China’s economy is on track for a ‘double dip’

China prides itself on its firm and “steadfast” leadership and stable economic growth. This should make his fortune easy to predict. But in recent months, the world’s second-largest economy has been full of surprises, contrary to seasoned China watchers and savvy investors.

In the first three months of this year, for example, China’s economy grew faster than expected, thanks to its surprisingly abrupt exit from the covid-19 pandemic. Then, in April and May, the opposite happened: the economy recovered more slowly than expected. Retail sales, investment and real estate sales figures all fell short of expectations. And the unemployment rate among China’s urban youth has topped 20%, the highest since data began recording in 2018. Some economists now believe the economy may not grow at all in the second quarter, compared to the first (see graph). By Chinese standards, that would count as a “double dip,” says Ting Lu of Nomura, a bank.

China also challenged a third prediction. Fortunately, it failed to become an inflationary force in the global economy. Its increased demand for oil this year has not prevented the price of Brent, the global benchmark, from falling more than 10% from its January peak. Steel and copper also depreciated. Producer prices in China, those charged ex-factory, were down more than 4% in May from a year earlier. And the yuan has weakened. The price Americans pay for imports from China fell 2% in May from a year earlier, according to the US Bureau of Labor Statistics.

Much of the slowdown can be attributed to the Chinese property market. Earlier in the year, it appeared to be recovering from a disastrous period of defaults, plummeting sales and mortgage boycotts. The government had made it easier for indebted property developers to raise funds so they could complete long-delayed building projects. And households that had refrained from buying last year, when China was subjected to sudden lockdowns, returned to the market in the first months of 2023 to make the purchases they had postponed. Some analysts have even allowed themselves the luxury of wondering if the real estate market might not rebound too strongly, reviving the speculative momentum of the past.

But this pent-up demand seems to have run out of steam. New home prices fell in May from the previous month, according to a population-weighted, seasonally-adjusted index of 70 cities by Goldman Sachs, a bank. And if real estate developers want to carry out real estate projects again, they hesitate to start them. Gavekal Dragonomics, a consultancy, calculates that property sales have fallen to 70% of the level they were at in the same period of 2019, China’s last relatively normal year. Housing starts are only around 40% of their 2019 level (see chart ).

How should the government react? For a worrying few weeks, it was unclear if he would react at all. Its growth target for this year, around 5%, lacked a lot of ambition. He seemed keen to limit the debts of local governments, which are often asked to splurge in the name of growth. The People’s Bank of China (PBOC), the country’s central bank, seemed unfazed by falling prices. He may also have feared that an interest rate cut could compress banks’ margins too much, because the interest rate they pay on deposits might not fall as much as the rate they charge on the loans.

But on June 6, the PBOC asked the country’s biggest lenders to lower their deposit rates, clearing the way for the central bank to cut its benchmark rate by 0.1 percentage points on June 13. The cut itself was negligible. But it showed that the government was not oblivious to the danger. Interest rates charged by banks to their “preferred” customers are likely to fall next, which will further lower mortgage rates. And a meeting of the State Council, China’s cabinet, on June 16 hinted at further steps to come (see chart).

Robin Xing of Morgan Stanley, a bank, expects further interest rate cuts. He also thinks restrictions on home purchases in first- and second-tier cities could be eased. The country’s “political banks” could provide more infrastructure loans. And its local governments could be allowed to issue more bonds. China’s budget suggests it expects land sales to remain flat in 2023. Instead, revenues have fallen about 20% so far this year, compared to the same period of 2022. If this deficit persists for the whole year, it would deprive local governments of more than one trillion yuan ($140 billion) in revenue, Xing said. The central government may feel compelled to fill this gap.

Will this be enough to achieve the government’s growth objective? Mr. Xing thinks so. The slowdown in the second quarter will only be a “hiccup”, he argues. China’s service-sector employment started this year at 30 million less than it would have been without the pandemic, Xing calculates. The rebound in “contact-intensive” services, such as restaurants, will restore 16 million of those jobs over the next 12 months. (In other North Asian economies, it took two to three quarters for those jobs to recover after the initial reopening, he points out.) And when jobs return, incomes, confidence and spending will resume.

Another 10 million missing jobs are in sectors like e-commerce and education that suffered from a regulatory storm in 2021, intended to curb market abuse, close regulatory loopholes and reassert government prerogatives. left. China has taken a softer tone toward these companies in recent months. This may embolden some of them to resume hiring, as the economy recovers.

Other economists are less optimistic. Bank of China International’s Xu Gao argues that further monetary easing will not work. Loan demand is insensitive to interest rates now that two of the economy’s biggest borrowers, property developers and local governments, are crippled by debt. The authorities lowered interest rates more out of resignation than hope.

He may be right. But it’s strange to assume that monetary easing won’t work until it’s actually been attempted. Credit demand is not the only channel through which it can revive the economy. In a thought experiment, Zhang Bin of the Chinese Academy of Social Sciences and his co-authors point out that if the central bank’s policy rate were cut by two percentage points, it would reduce China’s interest payments by 7 .1 trillion yuan, would increase the value of the stock market by 13.6 trillion yuan and push up property prices, boosting homeowner confidence.

If monetary easing does not work, the government will need to consider fiscal stimulus. Last year, the Local Government Finance Vehicles (LGFV), state-backed quasi-commercial entities, increased capital spending to support growth. This, however, left many of them strapped for cash. According to a recent survey of 2,892 such vehicles by the Rhodium Group, a research firm, only 567 had enough cash to meet their short-term debts. In two cities, Lanzhou, the capital of Gansu province, and Guilin, a southern city famous for its scenic karst mountains, interest payments by LGFVs reached more than 100% of the “fiscal capacity” of the city ​​(defined as their tax revenue plus net cash). flow of their financing vehicles). Their mountains of debt are not a pretty picture.

If the economy therefore needs a more vigorous fiscal push, the central government itself will have to organize it. In principle, this stimulus could include increased pension spending as well as freebies to consumers, such as the electric vehicle tax breaks that have helped boost car sales.

The government could also experiment with high-tech consumer aids of the kind launched by some cities in Zhejiang province at the start of the pandemic. They distributed millions of coupons through e-wallets, which would, for example, reduce a restaurant meal by 70 yuan if the coupon holder spent at least 210 yuan in one week. According to Zhenhua Li of the Ant Group Research Institute and her co-authors, these coupons, while small, pack a punch. They incurred more than 3 yuan in direct expenses for every yuan in public money.

Unfortunately, Chinese tax authorities still seem to view such donations as frivolous or wasteful. If the government is going to spend or lend, it wants to create a durable asset for its problems. In practice, therefore, any fiscal push is likely to drive more investment in green infrastructure, intercity transportation, and other public assets prioritized in China’s five-year plan. That would be the utterly surprising answer to China’s year of surprises.

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