China's Demand Dilemma

China’s demand dilemma

Ephemeral post-Covid recovery

Investors held high hopes for China when Covid restrictions were finally relaxed earlier this year. Consumers were expected to engage in “revenge spending” or “Baofuxing Xiaofei” (‘报复性消费) as restrictions relaxed. But instead, the Chinese economy has stalled. Consumers are unwilling to spend, the property sector is melting, and youth unemployment is so bad that the government is unwilling to release the figures.

China’s Covid experience was very different to most other nations. The country’s Herculean efforts to stamp out the virus at all costs meant life continued as normal domestically for almost eighteen months after the original Wuhan lockdown. China turned itself into a giant bubble. Factories continued to do reasonably well, feeding domestic demand but also its export market as locked-down citizens of Europe and America ordered Pelotons or Ergonomic office chairs to fit their working-from-home lifestyles. Domestic tourism thrived.

But all that changed when the Omicron variant reached the country in 2022. Brutal lockdowns of the type we saw in Shanghai crippled business plans amidst the uncertainty of when the country might change course. As the West opened up, China grew stricter. And so the country experienced the pandemic in a very different way, as something that was originally a rest-of-the-world problem to becoming the most severely affected country on earth. That upside-down experience means the nervousness has lingered.

Deflationary Spiral?

Chinese citizens have always had a greater proclivity to save vis-a-vis their Western counterparts. The average US employee saves 6-8% of his or her monthly pay cheque. In China, it’s around 32%. This trend is being exacerbated by declining consumer confidence in China. While Western nations continue to battle inflation, some commentators are becoming increasingly concerned about the prospect of deflation in China. Domestic producers are already slashing prices to encourage demand but this risks a spiral in which consumers hold off spending now in anticipation of even lower prices to come.

Housing Bubble

This deflationary trend is clear and drastic in the housing market. China’s property sector typically accounts for over a quarter of the overall economy. Official statistics show a resilient market with prices falling just 2.4% from an August 2021 peak. However, data from private providers and property agents paints a very different picture. These figures show prices falling at least 15% in major cities like Shanghai and Shenzhen.

In August, Country Garden, once China’s largest property developer revealed a $6.7 billion loss for the first half of 2023. The company missed coupon payments on international bonds earlier in the month. Country Garden’s chair, Yang Huiyan, now faces a battle to stave off the company’s collapse. Just two years ago, she was Asia’s richest woman.

Foreign investors sell-up

The gloomy outlook has resulted in unprecedented outflows of foreign capital in August 2023. $12 billion worth of Chinese stocks were sold as the government’s minimalist fiscal measures failed to allay concerns over slowing growth. Asset managers and analysts say the figures reflect the disappointment of those who had anticipated the launch of a broad government stimulus package. Sentiment has not been helped by continuing tensions with the US. Commerce Secretary Gina Raimondo recently warned that American companies were starting to see China as “uninvestable”.

Fiscal stimulus measures on the horizon?

The CCP has not been totally inactive in addressing the issues outlined. Local governments in Guangzhou and Shenzhen have eased mortgage conditions for first-time buyers to help an ailing property sector hit by defaults and delays. But the general approach remains a cautious one. Authorities recently unexpectedly held a core five-year lending rate out of fear that deeper cuts would put pressure on the banking system. Tellingly, Beijing has also set its lowest growth target in decades: five percent. This appears a tacit recognition that current economic headwinds cannot be addressed by government action.

Xi Jinping has little appetite for the financial aid policies enacted by other countries during the pandemic. There were no nationwide cash handouts and fiscal stimulus amounted to just a third of the aid offered in the United States. Chinese policymakers are wary of exacerbating the country’s growing debt risks with further loose monetary policy. Therefore, it seems highly unlikely we will see anything like the country’s 2008 response to the Global Financial Crisis. Back then, the country rolled out a four trillion fiscal policy that saw the economy grow by 9% in the latter half of 2009. But the measures also led to an unprecedented credit expansion which some blame for the woes of the property market today.

Fallout for the world economy

The impacts of China’s slowdown will be felt across the world. There is some good news in that Chinese raw materials, e.g. steel beams, may cost less as domestic demand slumps. This may help blunt the supply side shock that has contributed to inflation elsewhere. However, international companies that rely on Chinese spending will suffer.

The bigger question for investors is whether all this represents a bump on the road as China becomes the world’s largest economy. Or is this the start of a wider issue?