After three years of strict "zero-COVID" lockdowns, analysts had expected China's economy to quickly recover this year. But recent sets of data suggest otherwise. Retail sales, industrial output and investment in July all grew at a slower-than-expected pace. In the meantime, a fall in aggregate demand has put deflationary pressure on the world's second-largest economy.
How concerned should the United States be about the Chinese economy? How much have Beijing's policies contributed to woes in, for example, its property sector? Chinese policy makers were once known for being pragmatic, but can the pragmatism continue in the current political climate in Beijing?
NPR spoke to Tao Wang, author of the book, Making Sense of China's Economy. She's a former economist at the International Monetary Fund and is currently a managing director and chief China economist at UBS in Hong Kong.
2023 was supposed to be the year China's economy roared back. What went wrong? How much should we be concerned about China's economic trajectory?
The consensus expectation is that China's economy will recover this year after three years of zero-COVID policy. We expected the recovery to be driven by a rebound in consumption, led by normalization of economic activities and improvement in the labor market, and stabilization of the property sector. The economy rebounded in the first quarter largely as expected, and in the case of property and exports, slightly better than expected. However, going into the second quarter, property recovery faltered, with [housing] sales and starts falling much further. In addition, as local governments faced financing challenges, they tightened fiscal spending, which also constrained growth. Against this backdrop, the industrial sector started to destock and consumption recovery slowed in the second quarter. As a result, overall economic growth slumped in the second quarter.
At the Politburo meeting in late July, China's senior leadership recognized the difficulties facing the economy and vowed to roll out more supportive policies to help stabilize the economy. We expect an easing of fiscal policy with more credit support for infrastructure investment and modest easing of property policies. Our baseline forecast is quarter-on-quarter growth recovering to 4-4.5% in the third and fourth quarter, resulting in annual GDP growth reaching about 5% this year (the government's target for 2023), compared to barely 3% in 2022. The economy may not recover in the second half and growth would fall far short of 5% this year if the property sector does not stabilize, either because property policy is not eased significantly, or proven insufficient to halt the fall. In which case, a prolonged deep property downturn will continue to depress income and confidence of both the corporate and household sectors, as well as prices.
Did the government's regulatory tightening and deleveraging in the property sector in recent years play a role in the slowdown?
The government's property tightening measures in 2020-2021 were certainly a key trigger in the ongoing property downturn. But the latter was also due to major shifts in long-term real estate demand and supply, and was aggravated by the pandemic and related policies. Regulatory tightening on internet platforms, fintech companies and the after-school tutoring sector came out in a concentrated period of time a couple of years ago with little warning, leading to a sharp correction in those sectors. While the government has now signaled a normalization of regulations and vowed to support the private sector and internet companies, business confidence may take time and concrete reassuring measures to recover. Subdued business confidence is likely a factor behind weak private investment post-COVID, though falling profits and orders are also to blame.
State media hinted in the past weeks that there'd be more support to the property market. Would this be a game changer?
I think the current property downturn was brought about by changed fundamentals, earlier policy tightening and the pandemic. China's government already signaled a change in property policy late 2022, after recognizing that the biggest risk associated with property was no longer prices and leverage going higher, but a deep downturn dragging down the economy and endangering the financial system. However, the marginal easing so far has not been able to stop the downward trend in property activities. With a more supportive policy signal from the July Politburo meeting, the hope is that additional easing measures from local governments and various ministries can help stabilize property sales as well as pumping more credit to prevent developers from defaulting on a larger scale.
Given that there have not been sweeping property easing measures, it remains to be seen whether they will be sufficient to stabilize the property market soon. One thing is clear, however: The long-term property fundamentals have changed — China's population has likely peaked, urbanization is slowing and home ownership is already very high. This means that property demand and construction will remain significantly below the 2020-2021 peak levels even after they rebound from the current lows.
The issue of debt has been widely debated for many years. How serious is the problem now?
China's overall debt-to-GDP ratio is about 300% and rising, which is the highest among emerging markets and higher than most advanced economies as well. While China's central government debt is relatively small at just above 20% of GDP, debt at the local government level is estimated to be more than 70% of GDP. Moreover, many local governments do not have enough cash flow to pay interest on their debt. Some parts of the corporate sector, especially the property developers, are also now facing severe challenges to service their debt given the deep property slump.
Despite the high and rising debt level, we think the risk of a "typical" debt crisis or financial crisis where large defaults cause bank failures, severe credit crunch, and/or sharp exchange rate depreciation is relatively small in China.
Why?
One factor is that China's government has substantial assets that can be disposed of to help pay debt. More importantly, a debt crisis is typically a liquidity crisis, and in the case of China, high domestic saving kept by capital controls at domestic banks means that more than 95% of China's debt is domestic debt, financed by relatively stable domestic deposits and not subject to sentiment change of international investors. State ownership of the banks and the government's guarantees on deposits and track record also make bank runs highly unlikely. State ownership also means the government can prevent banks from withdrawing credit or otherwise causing a credit crunch. Meanwhile, the government can also inject capital or liquidity to support the operation of the banking system, and can coordinate relatively orderly debt restructuring, as opposed to market-enforced deleveraging, which can be messy and overshoot.
This does not mean China's high and rising debt level is not problematic. Evidence suggests that debt has been consistently rising faster than output over a prolonged period and a growing share is allocated to nonproductive sectors. Without market discipline to clear the low returns or failures of investment, inefficient and wasteful investments will crowd out more productive and profitable ones. This means misallocation of resources, depressed corporate profitability and investment, and lower long-term growth. The wasted resources will eventually end up as nonperforming debt, the cost of which will have to be borne by the financial sector and, ultimately, savers.
Your book tells a story of how China managed its economy since 1978. Now that the economy is at a crossroads again, what past lessons should China's leaders learn when they think about what's next?
China's economy is now facing significant challenges, with both the external environment and China's own economic fundamentals having changed. China's leaders can learn from their own experiences of navigating challenges in the past.
First, stay pragmatic and adaptive as they did in the past, adjusting policy priorities and tools in response to new challenges and changed circumstances.
Second, stay open and open further to the outside world — international trade, foreign investment, exchange of people and ideas, best international standards and practices have benefited China's development tremendously and are still important.
Third, push through key reforms and maintain the market-orientation — they were key to propel China's rapid development since 1978. Facing new challenges, China now needs to push forward with SOE [state-owned enterprises] reforms, hukou [household registration system] and pension reforms, supporting the private sector and revamping the fiscal system, to name a few.
