When two core indicators of Chinese inflation turned negative this week, alarm bells rang as the world’s second-largest economy started sliding into deflation. According to Joe Biden, China’s economy is a “ticking timebomb”.
The US president’s comments followed official data from China showing that July’s consumer prices index fell by 0.3% compared with 2022, while the producer prices index fell by 4.4%. It is the first time that both figures have been negative since November 2020, when the global economy had all but juddered to a halt during the peak of the Covid-19 pandemic.
It is not all bad news. Falling producer prices may help to quell global inflationary pressures. Analysts at Trivium China, a consulting firm, pointed out that consumer prices in July crept up compared with the previous month, a sign that the fall in consumer prices may have bottomed out. Core inflation, which excludes volatile food and energy prices, increased slightly in July. China’s GDP grew by 5.5% in the first half of the year, suggesting that it may be on track to reach Beijing’s modest target of 5% growth in 2023.
Many analysts expected that, after Beijing abandoned zero-Covid restrictions at the end of last year, China’s economy would roar back to life as consumers engaged in “revenge spending” after years of being cooped up at home. Household savings surged by 17.8tn yuan (£1.9tn) in 2022, cash which many thought would be burning holes in pockets. No such luck. Instead, the Chinese are consuming cautiously. During the May Day holiday, the number of domestic trips increased by nearly 20% compared with 2019, but the revenue from those trips was less than 1% more than before the pandemic.
“It’s quite shocking to see just how weak the rebound is in China,” says Adam Posen, president of the Peterson Institute for International Economics.
Household savings rates have continued to increase. Fast economic growth and a weak social safety net means that the Chinese have long been savers. But personal deposits in June reached a record 133.1tn yuan, despite the banks repeatedly cutting rates. “The average Chinese consumer and small business has been lastingly spooked by the way that the zero-Covid system was run in China,” says Posen. It was “such a break from the way that successive Chinese leaders have behaved, where they have generally left people alone as long as they weren’t political, that it changed [ordinary people’s] mindsets”.
“People seem to be moving into more liquid assets which is usually a sign of fear, it’s self-insurance,” Posen says.
While spending in certain sectors of the economy increased in the first half of the year from a low base in 2022, this was mainly on smaller items such as jewellery and clothes, which increased by 17.5% and 12.8% respectively. Spending on bigger items such as cars and furniture, which would indicate more long-term confidence, has been slower. Sales of building materials, which reflect confidence in the property sector, declined by nearly 7%.
The lodestar of China’s economy is in trouble. Real estate accounts for almost 30% of GDP once related activities are taken into account, but for the past two years the industry has been in crisis since a government crackdown on over-leveraging in the sector meant that property developers were suddenly unable to access financing. That, plus zero-Covid measures, meant that the construction of hundreds of developments stalled, which led to buyers being left without homes despite already having made hefty down payments. Confidence in the sector was shattered. Investment in real estate, which already had its worst year on record in 2022, declined by 7.9% in the first six months of 2023.
On Thursday, Country Garden, China’s biggest property developer, said it expected to post a multibillion-dollar loss in the first half of this year. The filing was made days after it missed two dollar bond interest payments, prompting fears of a default for the company that was worth $50bn at its peak in 2018, but is now worth just $3.3bn. Country Garden is one of the last big property developers yet to default, but on Friday its shares fell by 14%, closing below HK$1 (£0.10) for the first time at HK$0.89.
Country Garden has more than four times as many housing projects in China than Evergrande, the second-biggest developer, which defaulted in 2021. That prompted widespread economic panic and mortgage boycotts in nearly 350 developments. Country Garden promised on Thursday to deliver nearly 700,000 units this year, a similar number to 2022, but JP Morgan has said that home sales may fall by more than 80% in the second half of this year as the turmoil scares off potential homebuyers.
Some of the property sector’s problems are structural. In recent years, the rate of urbanisation has slowed, cooling demand for housing in second and third-tier cities. The plummeting marriage and birthrates also mean there is less demand for newer and bigger homes, as does the fact that, with youth unemployment at a record 21.3%, many young people are choosing to stay at home with their parents for longer.
The question now is whether Beijing will resort to stimulus measures. After the 2008 financial crisis, Beijing encouraged local governments to borrow more to fund big infrastructure projects. But rather than being a much-needed one-off boost to the economy, that stimulus policy “institutionalised fiscal irresponsibility on a massive scale”, notes Andrew Batson, China research director at Gavekal Dragonomics, a consulting firm, which may make China’s leaders cautious about writing cheques this time around.
Xi Jinping, China’s leader, has emphasised the need for “high quality growth”, focusing on advanced technologies and self-sufficiency rather than rapid increases in GDP. At a recent politburo meeting, Communist party leaders did not indicate any plans to significantly loosen fiscal or monetary policy. They did, however, promise to address China’s ballooning local government debt problem. The slowdown in the property sector and the spending on zero-Covid measures hit the books of these authorities, which were already heavily indebted after years of overspending on infrastructure projects. The total size of local governments’ debt burden is estimated to be between $13tn and $23tn – the true figure is hard to grasp because much of it is hidden in opaque off-balance-sheet entities – and economists have said that many provinces are on the brink of default. China’s state council will reportedly soon send working groups from the central bank and finance ministry to the most indebted provinces to help them find ways to cut their liabilities.
Still, many experts think that more government support is needed. “The lack of a big-bang stimulus means that 3Q growth won’t be rosy,” said Houze Song, a fellow who researches the Chinese economy at MacroPolo, a thinktank. Although Song, like many economists, thinks that the economy will soon start to slowly stabilise, without a boost in confidence, he predicts, “the economy will remain in the doldrums”.
