Last week’s news that China’s GDP grew 5.2 per cent in 2023 gave some comfort to policymakers in Beijing. The data allowed them to claim success over their target to grow the economy by around 5 per cent for the whole year.
But the mood among Chinese households and corporates is much bleaker than the data suggest; and without the post-lockdown economic bounce that supported China’s growth rate in 2023, growth looks set to weaken this year, limiting the support that China might provide for the rest of the world economy.
A deflationary trap
Chinese households are gloomy to a large degree because the value of their main asset, namely property, has been suffering losses for a considerable time now. Real estate prices across 70 cities have been falling consistently since April 2022, hardly conducive to a ‘positive wealth effect’ that might encourage households to go out and spend.
The result is that China is at the edge of a deflationary trap: consumer price inflation has been negative in four of the past six months. This risks turning into a self-reinforcing spiral if households postpone purchases in the hope that prices continue to fall – a dynamic that isn’t helped by China’s falling population.
While it’s true that retail sales rose 7.2 per cent for the whole of 2023, this should be seen as a kind of failure: apart from 2020 and 2022, two years badly affected by COVID-related lockdowns, that growth rate is the weakest China has seen since 1999.
And employment prospects are bleak, largely because Chinese firms seem unwilling to invest. Although the government tried to revive ‘animal spirits’ among Chinese corporates after the Party’s 20th Congress in late 2022, the effort hasn’t yielded much. Companies remain anxious about how far their autonomy stretches in a country where the government has expressed a commitment to contain what it calls the ‘unrestrained expansion of capital’. Only last month regulators announced new rules restricting Chinese spending on online games.
Meanwhile, the external demand environment facing Chinese exporters will be fragile. The past two years of monetary tightening will induce an unavoidable slowdown in the US and persistent weakness in Europe, as will those countries’ further efforts to restrict the access of Chinese exports in the context of rising geopolitical competition.
Anxiety on public sector debt
Against this rather mute background, it remains a surprise to many that Chinese officials haven’t delivered anything close to a ‘big bazooka’ stimulus. Essentially, though, the authorities remain unable to deliver a large monetary stimulus and unwilling to deliver a large fiscal one.
Loosening Chinese monetary conditions would involve either cutting interest rates by a lot or allowing the renminbi to weaken. But deploying either of these tools would likely lead to accelerated capital outflows, undermining confidence.
US 3-month interest rates are close to 5.3 per cent, more than double the equivalent rate available in China: any further widening of that differential would suck more money out of the country, capital controls notwithstanding.
And any effort to weaken the renminbi would have the same consequence because of the way in which currency depreciation induces expectations of further depreciation, and thus encourages outflows.
And the authorities seem largely unwilling to deliver much in the way of a fiscal stimulus. It’s not that nothing has been done. A trillion renminbi worth of special bond issuance was authorised late last year, which could push the budget deficit up to 3.8 per cent of GDP in 2024. And China’s policy banks had an injection of central bank funding in December as part of a quasi-fiscal boost to the economy.
But policymakers in Beijing are in a state of high anxiety about the level of China’s total public sector debt which, including local government liabilities, approached 110 per cent of GDP in 2022 by the IMF’s reckoning.
That anxiety was on full display last month at two crucial policy meetings. One of the key messages of the December Politburo meeting was the need for the government ‘do one’s best within one’s ability’, hardly a clarion call for stimulus. And the Central Economic Work Conference was also rather downbeat in its emphasis that ‘high-quality development’, rather than fast growth, is the ‘hard truth of the modern era’.
That ‘hard truth’ has one major source, namely the government’s unshakeable determination to wean the Chinese economy off its dependence on real estate investment.
The government’s aim is to is to free up capital and credit resources in order to support new kinds of investment that Beijing wants to promote: high-tech, agriculture, green energy.
It is this kind of investment, rather than more empty buildings, that China needs to protect itself from hostile trade policy and the future risk of Western sanctions.
Even under the best of circumstances, the economic transition that China is aiming for would be very tough. Add to that the challenges of a shrinking population, a falling price level, a number of hostile trading partners and largely unhappy households, and China’s economy will be a growing source of concern to policymakers worldwide.
David Lubin, Michael Klein Senior Research Fellow, Global Economy and Finance Programme.