Focus
April 12, 2024 | 13:41
China: New Forces at Work
China: New Forces at WorkMuch to the relief of the Chinese authorities and beleaguered stock market participants, most of the economic data released this year have exceeded market expectations. Notably, fixed investment rose 4.2% y/y, retail sales grew 5.5% y/y, and industrial profits climbed 10.2% y/y in the combined January-February period (Table 1). Nevertheless, we are of the view that the economy still has a tough road ahead, which was highlighted by exports’ 7.5% y/y drop in March. Even Beijing openly acknowledged in its heavily scrutinized Government Work Report (GWR) that achieving the 2024 economic targets, namely real GDP growth of around 5%, “will not be easy”. |
Extended Housing Downturn |
The housing market, estimated to account for between 20%-to-30% of economic activity, is likely to remain a heavy drag even though it has already been over two and a half years since the Evergrande debt crisis erupted. The good news is that that episode did not morph into a full-blown financial crisis as banks avoided becoming saddled with large amounts of non-performing mortgage and corporate loans. Bank lending standards were quite tight previously with maximum loan-to-value (LTV) ratios standing at 70% for first-time home buyers and 60% for second homes before recent loosening. The crux of China’s real estate crisis was that many homebuilders were extremely aggressive, borrowing extensively (via bank loans and, over time, greater bond issuance), acquiring large land banks and preselling more apartments than they could deliver in a timely manner (Chart 1). |
The housing market will likely take several years to truly recover, or more, hindered by the authorities’ slow and still-evolving policy response. This is reflected in Beijing’s latest directive for cities to create a ‘whitelist’ of stalled housing projects that banks will, in turn, finance to help jumpstart deliveries. Thus, it should come as little surprise that potential buyers, especially in lower-tiered cities, are likely to continue to sit on the sidelines amid the ongoing uncertainty. Moreover, it’s become evident that confidence in housing as a store of value (i.e., owning multiple homes for investment) has been severely damaged. It also appears that demographic forces (i.e., prior one-child policy) are likely to increasingly weigh on future housing demand. Glancing at China’s population pyramid, one cannot help but notice the sharp drop in the population aged 20-to-29, compared to 30-to-39 cohort (Chart 2). Such developments explain why the IMF recently estimated that the housing market may not bottom out until 2026, only gradually recovering thereafter. This suggests that housing prices may continue to sag and undermine consumer confidence/spending via the negative wealth effect, given a large share of household wealth is tied up in real estate (60%-to-80% of total assets). |
Job Woes GrowGetting a good handle on the labour market in China is not easy given the sheer size of the economy. The benchmark urban unemployment rate does not seem to reflect the true state of the job market as it has proven to be quite sticky, rising to 5.3% in February, up from 5.0% a few months ago and only a touch above its long-run average of 5.2%. Nonetheless, by all accounts, the job market is much weaker than pre-pandemic days. There are two areas of concern: (1) Anecdotal reports suggest that labour market conditions have deteriorated for migrant workers from rural areas, who still account for a sizeable share of the national workforce and are excluded from the urban employment survey. The employment sub-index in the manufacturing PMI remains in contraction territory, averaging 48 in 2024Q1. (2) Service-based sectors are also under stress. Zhaopin.com, one of the leading online recruitment platforms, revealed that average salaries of new hires in 38 key cities remained sluggish, rising 2.2% y/y in 2024Q1. A prior survey showed that 32% of white-collar workers said their wages fell in 2023, compared to 44% reporting an increase. The soft job market is likely a key reason behind increased efforts to lure foreign companies back, highlighted by Beijing’s pledge that foreign firms would receive “equal treatment” to local companies. Beijing undoubtedly wants to mitigate pressures emanating from the West’s increasing restrictions on tech exports to the country and the ‘China Plus One’ strategy. Recall foreign companies have been diversifying their supply chains outside of China in an effort to reduce concentration risk and also to evade higher U.S. import tariffs directed at the mainland. Beyond attempting to slow the relocation of manufacturing outside the country, the desire to re-attract foreign direct investment (FDI) is multi-faceted. The authorities clearly have other goals in mind, including attempting to de-escalate trade tensions with the West, creating higher quality jobs and boosting domestic business confidence. Economic Policy under the Microscope |
We suspect the chorus of calls for greater fiscal and monetary stimulus will continue to grow as re-attracting FDI will prove difficult. Honing in on the fiscal position, a big source of concern is that policy remains heavily geared towards supporting infrastructure spending rather than consumer spending. Based on details released at the National People’s Congress in early March, this year’s fiscal stance has turned (modestly) expansionary (Chart 3). But, it’s admittedly hard to gauge to what extent since the official budget (the general fiscal account), which is targeting a deficit of 3.0% of GDP (vs. 3.9% of GDP in 2023), is only one of China’s four key fiscal accounts. Beijing does not announce targets for the government fund account, state-owned enterprise fund account or Social Security fund. Of these three, the government fund account matters the most as it includes physical infrastructure spending. It’s also worth emphasizing that the budget does not account for the activities of local government financing vehicles, which are basically contingent liabilities of local governments. The decision to introduce CNY1.0 trillion (or 0.8% of 2023 GDP) in new ultra-long-term special treasury bonds shows that the authorities remain laser-focused on climbing up the value-added ladder and competing economically with the West. The new bond issuance will be used to finance activity in the government fund account related to technological innovation, the green transition and projects of strategic interest. Note that the GWR did mention that reforms would be advanced to improve the social safety net, including healthcare, elderly care, social security and income distribution, but that’s clearly not a key priority. |
Tech Moves into Overdrive |
Indeed, the GWR highlighted that Beijing’s number one objective this year is to focus on innovation, namely “developing new quality productive forces at a faster pace”. The emphasis on new productive forces (e.g., artificial intelligence, biomanufacturing, low-altitude transportation, etc.) highlights that the Middle Kingdom is looking to expand its technological frontier beyond the recent successes in electric vehicles, lithium-ion batteries, and solar products. All this explains why investment is booming in many high-tech-related sectors (Table 2) and why the country’s role as the world’s factory won’t evaporate overnight (Chart 4). On the flip side, many high-tech activities are quite capital-intensive, which may not provide a big boost to the job market, or are in fact still suffering from a shortage of talent (i.e., STEM workers). Nonetheless, it’s clear that tech’s role in the economy, which still trails housing by a wide margin, could rapidly catch up in the next few years. The focus on industrial upgrading means that the longstanding goal of rebalancing the economy from investment-led to consumption-driven growth will likely be delayed further (Chart 5). This could lead to persistent disinflationary pressures (due to excess supply) and greater trade frictions as Chinese manufacturers become increasingly reliant on overseas markets to sell their goods. This was underscored by U.S. Treasury Secretary Janet Yellen, who warned on her recent visit to China of the risk of “overproduction of certain goods”. We think that Beijing’s current focus on national security, particularly economic self-reliance, isn’t likely to ease. The authorities are keen to prevent the country’s import bill from rising too quickly, which could shift the current account into deficit from surplus (Chart 6). This would increase the risk of the economy becoming dependent on foreign capital, eroding the banking sector’s deposit base and potentially constricting domestic credit. Key Takeaway: There are some encouraging signs that the Middle Kingdom’s economy may finally be bottoming out after a couple of tough years. Thus, we have nudged up our 2024 real GDP forecast to 4.6% from 4.4%. However, it’s not all blue skies ahead as the economy is facing some major domestic and external headwinds (e.g., excessive debt, extended housing downturn, rising global protectionism). Still, the authorities appear likely to tolerate a bumpy road as they remain intent on bolstering the country’s technological prowess. |