Macro Insights Weekly: China’s economic distress and the outlook ahead
- Attempts to reduce property sector leverage is slowing down the economy sharply
- “Zero-Covid” policy has affected domestic service sector considerably
- The war in Ukraine poses substantial risk to China’s export sector
- Regulatory crackdown has soured investor sentiment on tech and other sectors
- Fiscal and monetary policy support has begun; much more will come after the 20th Party Congress
Commentary: China’s economic distress and the outlook ahead
It has been a torrid year for China, with stress from multiple parts of the economy weighing down growth, pushing up financial market stability concerns, and by extension souring an already fragile global consumption and investment environment. Our Nowcasting model suggests only a mild turnaround in growth in Q3 after a near flat outturn in Q2. We are looking at no more than 3.5% growth in 2022, with the balance of forecast risks tilted to the downside, especially if export demand from Western economies begins to weaken rapidly.
There are four key drivers of China’s travails:
First, the “three red line” policy introduced in 2020 to reduce leverage in the real estate sector has manifested in financial distress among developers. Bank loans and bonds on the sector have sharply declined in value, while home loan demand has slowed, along with property sector construction and investment. The unwinding of the property boom, a major driver of GDP growth over the past two decades, is a sizeable risk for the Chinese economy. Properties make up nearly 60% of Chinese household wealth, so the negative wealth effect from declining housing prices (which is taking place presently) is a considerable drag to consumption.
Second, China’s ongoing battle with the pandemic. After showing the world how to deal with the coronavirus outbreak in 2020 before vaccines came along, China has struggled to inoculate its elderly population with effective vaccines, which in turn has forced it to pursue stringency measures that have seen episodic shutdowns across major cities. The service sector and consumer confidence have been affected, and some manufacturing related disruptions are also visible.
Third, the Russian invasion of Ukraine, which in some respect has allowed China to secure natural resources from sanctions-hit Russia, has been negative for the global economy, with percolating stagflation risks. China’s export sector, which has boomed over the past two years, is likely to face waning global demand as recessionary headwinds gather in the West.
And finally, a major shift in economic priorities towards “common prosperity,” which has led to a regulatory crackdown on tech and other companies, adding to major investor uncertainty and darkening the outlook for private sector investment considerably.
China’s loss of domestic growth momentum has affected foreign investor sentiment, which is evident from the data on portfolio and foreign direct investment. Parts of China’s equity and bond markets continue offer opportunities, but the number of speculators willing to brave the brewing uncertainties has dwindled.
We don’t think headwinds to property and tech sectors will persist much longer. After next month’s party meeting, we and many in the analyst community expect easing with respect to pandemic related restrictions on mobility. We also think a lot more fiscal and monetary support for the property sector is forthcoming. The clock is ticking.
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