What happened to China’s recovery?
Hopes were high for Chinese markets after Beijing lifted the country’s draconian Covid restrictions late in 2022. However, after a rebound early in the year, the performance of both equities and the economy has been weak. Where did it all go wrong?
While most major economies have spent the past year trying to slow spending and lower inflation, China finds itself in a very different position. It is in the midst of a significant slowdown and needs to stimulate its economy. The Covid restrictions that hampered China’s economy for the past two years may have gone – but the faltering property market has quickly replaced it as a major headwind to confidence and activity. Economists have been downgrading their expectations for China’s GDP growth in 2023 and suggest the lowest target the government has set for economic growth in decades – 5% – may only just be cleared. At the start of the year, the picture looked very different. Optimism about China’s post-Covid reopening saw the MSCI China All Shares index rise by more than 50% from its low point in October 2022. Many expected the rally to continue. Instead, markets have steadily moved lower – and calls for a significant government stimulus package grow louder.
China’s stock market: key recent developments
Property: the elephant in the room
For many years, property has been a key driver of China’s fortunes. It accounts for around three-quarters of Chinese wealth and a third of annual output. Property prices have been falling for over a year now and, unsurprisingly, this is taking a heavy toll on economic activity. This “structural” headwind may explain why the post-Covid rebound was not as meaningful, and did not last as long, as in other countries.
Chinese property prices started falling in early 2022
New house prices, year on year change %
Source: Refinitiv Datastream, September 2023 Investing 12 dialogue October 2023
Unfortunately, falling property prices are not just an issue of consumer confidence. They also come with significant risks for huge swathes of the financial sector, including banks and property developers. Chinese developers have been under pressure since the government’s “Three Red Lines” policy was introduced in 2020, restricting the amount and type of debt that the sector could use. This meant that developers could not simply roll over their debt – and were instead relying on property sales to meet their obligations. As the property market cooled, casualties started mounting. Evergrande, one of the largest developers in the country, defaulted on a bond in 2021. Smaller rivals followed suit. As property prices started actually falling last year, more developers have become distressed. Country Garden, another very large developer, delayed interest payments on two bonds earlier this year. The pain is spreading. Lacking buyers for their current stock, homebuilders haven’t been buying land for new developments. This has hurt local governments that rely on land sales to fund infrastructure projects. So they are now also struggling with liquidity and potential defaults.
Limited steps to restore confidence
The government has been taking some steps to boost demand for property. For example, the minimum downpayment for first-time buyers in the largest cities is typically 30-40% of the property’s value while downpayments for second homes are usually in the 50%-80% range. The government has been trying to nudge downpayments lower by setting a nationwide minimum of 20% for first-time buyers and 30% for second-home buyers. All else being equal, lower downpayments should boost affordability and drive up demand. The government has also lowered interest rates in the tightly-controlled mortgage market. In August, mortgage rates for existing first-time buyers were reduced slightly. While this is a welcome boost for existing home owners it does little to boost demand for currently empty homes – and it puts pressure on banks that are already seeing their margins squeezed by weak loan demand.
No joy from jobs
One of the factors driving inflation in the West is the strength of the jobs market, allowing workers to keep spending despite steep rises in interest rates. In China, however, the unemployment rate recently rose above 5% compared to a long-run average of around 4%. Meanwhile the youth unemployment rate is at the highest level since records began – above 20%. Young workers represent only a small proportion of the overall workforce, but their prospects are of particular importance in a country whose working population is shrinking. The government recently decided to stop publishing the youth unemployment figures.
One challenge is that exports have been weakening over the course of the year as global growth has slowed and potentially also as a result of companies changing their supply chains. The export of goods and services represents around 20% of China’s GDP, so this is another major challenge for the overall economy. The slowdown in exports has been putting pressure on jobs in manufacturing, which accounts for a significant share of exports.
Chinese exports and imports have both been falling...
Year-on-year change, %
... and retail sales growth has almost stalled
Year-on-year change, %
Source: Refinitiv Datastream, September 2023
Unfortunately, domestic demand isn’t currently providing much offset. Weak domestic demand is best illustrated by retail sales data. After a big pickup following the end of lockdowns, growth in consumer spending has been tailing off since April. The weakness in property is likely a contributing factor. When consumers aren’t buying new homes, they are probably buying less furniture and new appliances. This will concern the government as they have long pointed to domestic consumption as a key plank of their economic policy.
What does it all mean?
Property and exports – the two key sectors of the Chinese economy – are both weak, weighing on employment and sentiment across the country. The economy is clearly in need of a boost.
While the government cannot stimulate external demand, stabilising the property market is a crucial first step to restoring confidence. We expect to see further measures over the coming months. However, the government has made it clear that it will not pursue the kind of “shock-and-awe” stimulus measures that it has resorted to in the past. Beijing’s focus is on “better quality growth” even if it takes longer for the economy to recover. Despite the challenges, we still see selected opportunities in China. There are areas where Chinese companies remain global leaders, such as solar and EV technology. And over the longer term, rising incomes should support growth in sectors such as healthcare and insurance. However, weak growth prospects in the near term, and the government’s more disciplined approach to stimulus, could well mean that Chinese markets struggle, and potentially become more volatile, over the coming months.
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