There has been a steady drumbeat of dire economic news out of China in May, pointing to a contraction in the economy in the second quarter. This comes at a tricky time for President Xi who is trying to secure a third term as Chinese President later this year. On the positive side, reported COVID-19 cases have fallen very sharply and Shanghai is gradually beginning to reopen. But any further large spikes in virus cases present major downside risks for the economy this year.
Expectations were already low after the very gloomy picture painted at the beginning of the month by the purchasing-managers’ surveys, and yet the hard data this week still managed to surprise to the downside. Industrial output contracted by 2.9% on a twelve-month basis, with a seasonally adjusted monthly decline of over 7%. Retail sales dropped by more than 11% on a year-on-year basis, with a particularly sharp fall in car sales. Fixed-asset investment exhibited some resilience, rising 6.8% on a twelve-month basis, although this was weaker than in March. New bank lending registered its lowest monthly rise since December 2017.
The deterioration in the labour market has been striking, with Premier Li Keqiang describing the employment market as “complicated and grim”. The surveyed rate of urban unemployment has risen markedly over recent quarters and is now well above the early 2020 peak in 31 large cities. It is particularly elevated among 16-24-year-olds, rising from 14.3% in December to over 18% in April. This comes in a year when a record 11 million students are due to graduate from Chinese universities. The authorities will increasingly worry about the risks to social stability if unemployment continues to spike.
Perhaps unsurprisingly, housing activity remains firmly in the doldrums. In the first four months of the year, the areas of floor space started and sold were down 28% and 25% respectively compared with the same period in 2021, while the area of land purchased by real estate developers was almost 50% lower. This will add to pressures on local government finances, already hit by a weakening economy, and by the costs of stimulus measures and of administering the ‘zero-Covid’ policy. There was further housing-related policy easing. The central bank cut its 5-year Loan Prime Rate by 15bps and has allowed financial institutions to lower mortgage rates by an additional 20bps for first-time buyers. Policymakers are in a tricky position. Their policies have created a massive bubble in the housing market over the past decade, which appears to be bursting. It may be difficult to prevent this without an aggressive easing in policy that changes the narrative on the outlook for the sector, but also risks inflating the bubble more.
Exports may provide less support to the economy than in recent years. Export growth slowed to just 3.8% on a twelve-month basis in April, compared to the bumper year in 2021 when exports increased by almost a third and net trade contributed 1.7 percentage points to annual growth. Some of the recent decline is likely to reflect supply-chain issues during the spike in COVID-19 cases, but it may also signal slowing demand in overseas markets. Surging inflation and policy tightening could further hamper demand growth in key markets such as the US and Western Europe over coming quarters.
On a more positive note, new reported virus cases in China have plummeted. New daily cases in Shanghai have been below 1000 this week, down from a peak of over 27,000 in mid-April, and officials have suggested that they will continue to gradually loosen restrictions and open up the economy. This could be a slow process, however, as the authorities will not want to risk a resurgence in cases.
The sharp deterioration in the Chinese economy in the second quarter comes at a particularly tricky time for President Xi. He will be seeking a precedent-breaking third consecutive term as President of China at the upcoming National Party Congress, most likely in November. The political horse-trading around this and around key appointments to the Politburo and its Standing Committee is likely to be already in full flow. The odds are still in favour of Xi winning another five-year term, but he is looking much less of a sure bet than was the case just a month ago. If the economy continues to languish over coming quarters, then all bets could be off.
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