Weekly Commentary

When the Chinese leadership decided in December 2022 to abolish the draconian corona measures that had brought the country socially and economically to the brink of breaking point, it nurtured hopes for a rapid recovery of the Chinese economy. In an otherwise cooling global demand environment, many observers at the time hoped that Chinese household savings, swollen by the equivalent of $2.6 trillion in 2022 as a result of the Corona restrictions, would translate into "revenge spending," purchases to compensate for the lifetime lost to Corona. This consumer "revenge," it was assumed, would boost the Chinese economy in the form of exceptionally high growth during the first two quarters of 2023. The rest of the world hoped that its weak growth would at least be mitigated by China's newfound strength. After China's first strong quarter of 2023 with decent growth (+4.5% y/y), the high hopes for China all but evaporated in the second quarter. Therefore: Fiddlesticks!

Industry, consumption, and investment weaken

When we talk about disappointing growth in China, we are by no means talking about an impending recession, as in the USA, but rather about a slowdown in growth. Several economic indicators can be used as examples of this: For example, although industrial output still rose by 3.5% y/y in May, this increase is significantly lower than the April figure (+5.6% y/y). The situation is similar for consumption: Measured in retail sales, there was an increase of 12.7% (y/y) in May. One circumstance that supported the high year-on-year growth in retail sales here was the low baseline of 2022 when widespread curfews in China limited consumption opportunities. Investment has also slowed: In the January-April period, growth of 4.7% (y/y) had still been recorded; now - as a result of a weak month of May - growth in the January-May period has weakened to 4% (y/y).

Decline in exports, real estate crisis, and inflation worries

However, there are also economic indicators that even paint a significantly gloomier picture: Foreign trade, which has so far been an important pillar of growth for the Chinese economy, is not at all convincing. In June 2023, exports fell by 12.4% year-on-year. The real estate market has still not been able to shake off its crisis, even with the help of government support measures. Real estate developers, in particular, are still suffering from their tattered image, which is scaring off banks and customers. This is particularly noticeable in the volume of residential sales in May; measured in terms of residential space, these fell by around 20% year-on-year. According to our calculations, housing starts are therefore expected to fall by 9.2% q/q in the second quarter of 2023. Consumer and producer prices do not appear to be taming at the moment either. In the case of producer prices, the country is already in a deflationary phase compared with the industrialized nations. The producer price index (PPI) fell by 5.4% year-on-year in June, following a 4.6% drop in May. The consumer price index was unchanged year-on-year (0%) but fell by 0.2% month-on-month. The price development exposes, in particular, the glaring weakness of consumption and industry in China.

Scars of the past

There are many reasons for the current weakness of the Chinese economy: As the world's workbench, China is dependent on strong demand from industrialized nations, which is increasingly cooling off. This is putting a particular strain on Chinese industry and the country's exports. Consumption in China has structural problems, which can be seen, among other things, in the high household savings rate (OECD; 2019: 34.8% China vs. 9.1% USA), as this reveals difficulties in creating more growth from domestic consumption, following the example of the USA. For this reason, hardly any growth impetus can be expected from consumption. Investment and the real estate market are suffering from a massive confidence problem, as the in part arbitrary reform interventions of recent years have severely called into question faith in China's solidity, in the economic location in general, and its attractiveness as an attractive real estate market in particular. Further challenges arise from the intensifying rivalry between the U.S. and China, which has led to growing geopolitical uncertainty and Western technology constraints. All aspects weaken China as a business location. But another aspect that is now receiving too little attention is that China is arguably still struggling with the late effects of the covid pandemic: this struggle is not limited to the health sphere but probably also to the economic sphere. China's former finance minister Lou Jiwei recently put it succinctly: "The scarring caused by the pandemic is relatively severe." He went on to say that it will take time for households and businesses to recover from these scars.

No good alternatives

The question now is, what can the Chinese leadership do about the weakness that is setting in? Stubbornly weak consumption, confidence problems weakening investment and the construction sector, intensified rivalry with the U.S., and the aftermath of the Covid pandemic will take time and a great deal of political skill, above all, to even begin to be resolved. Given the acute challenges, however, short-term solutions must also be considered. In China's case, these are anything but simple. If the economy is supported by monetary policy, as has already been done in the form of key interest rate cuts of 10 bp each, then the room for maneuvering for the Chinese central bank (PBoC) appears to be very limited. This is because it runs the risk that the outflow of foreign capital will increase due to the growing interest rate differential with U.S. bonds and that the depreciation of the weak renminbi (currently at 7.19 CNY/USD) will continue. A spirited fiscal policy support is also not to be expected, as the era of bazooka-like infrastructure programs seems to be over. Stimuli such as those launched by Beijing after the financial crisis in the noughties (totaling USD 585 billion) not only resulted in rapid growth but also left behind unneeded infrastructure - in the form of barely used bridges and highways. We assume that further support measures will be taken by Beijing, but these are more likely to be targeted interventions, e.g., for the real estate sector, e-vehicles. This should show that the Chinese leadership has been purged of past mistakes and now prioritizes competing target dimensions besides growth, such as national security, debt control, and qualitative growth.

Conclusion

There are no quick and easy solutions to China's acute economic problems. Thus, the economic rebound, in which so many (also global) hopes were placed, seems to have come to an end after only one quarter. In the absence of significant support measures, economic growth is likely to decline further. It can be assumed that after the strong growth result in the first quarter of this year (+4.5% y/y), the second quarter will probably be much weaker (forecast: +0.5% y/y). We have therefore adjusted our GDP expectations downward for 2023 as a whole. Currently, instead of 5.8% y/y, we expect GDP growth of only 5% y/y in 2023. However, this is in line with the growth target issued by the Chinese leadership at the beginning of the year. Anyone who now still believes that China's economy can support the global economy is "Pustekuchen" (the German word for fiddlesticks) - "Pustekuchen" in the sense of the Yiddish original meaning of this word, i.e., "little wise.”