China’s reopening after three years of unprecedented and draconian zero-COVID policy has been one of the most keenly watched stories in markets this year. At first it was unclear how significant the bounce-back was going to be, but now, three months into 2023, some key indicators have started to shed some light on the shape of the recovery. Most important was the GDP number for 2023 Q1, which was reported to be 4.5% on an annual basis, beating expectations of a 4.0% increase. According to the official numbers at least, China’s recovery appears to have started on the right foot.
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Traditionally, China’s GDP growth has been characterised by an excessive reliance on investment, to a large degree unproductive investment. Over time this has resulted in an unbalanced composition of growth that favours savings over consumption. We are always looking for evidence that China is rebalancing towards private consumption. Recent data, taken at face value, point to more balanced growth — as shown by the improved relative performance of retail sales against industrial production. It is prudent to take this data with a pinch of salt. The nature of the lockdown, in which households were prevented from spending on activities, while the manufacturing sector proved more resilient and thus had less room for recovery, means that some rebalancing is to be expected now those restrictions have been eased. But the change in the composition of growth is likely to be temporary: in the longer term, the former unbalanced pattern will probably be re-established.
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The biggest positive surprise in the performance of the Chinese economy this quarter has been the external sector, with exports rising by 14% in annual terms in March, reversing the downward trend of the previous five months. The positive data were triggered by a sharp increase in demand from countries within the Association of Southeast Asian Nations (ASEAN), which is China’s main trading partner, and who are therefore likely to enjoy the most benefit from China’s reopening. Exports to the United States and the European Union also improved, but this is likely to prove short-lived, given the high likelihood of recessions in most advanced economies later in the year.
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Another important shift has taken place in the housing market. Over the past few years confidence in the Chinese real-estate sector has been hit hard, and the zero-COVID period fueled this negative trend as demand for housing collapsed, while supply was restricted due to credit constraints aimed at reducing the leverage in the sector. To counter this shock, in late 2022 the government introduced a set of policies intended to encourage property financing. These measures, together with the reopening of the economy, are helping the sector to emerge from its slump. House prices increased 0.5% in March, which is the highest monthly increase in almost two years, while sentiment has shifted positively. However, confidence in the sector is still very damaged, and structural issues in the housing market have not yet been addressed, resulting in a sluggish recovery that is unlikely to go too far.
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Despite the stronger role that consumption is playing in China’s growth (at least temporarily), inflation has remained surprisingly weak throughout the quarter, in sharp contrast with the rest of the world. This puzzle can be solved if we consider the fact that fiscal policy in China targets the supply side of the economy instead of the demand side, usually in the form of state subsidies to the industrial sector. This results in a net disinflationary effect, which is unlikely to change unless fiscal policy starts supporting consumers directly — something to which Fathom attaches a very low probability.
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So the Chinese recovery is already under way; but it is likely to be temporary, and is not exempt from downside risks. In particular we consider that the consumer splurge is unlikely to last long, as our estimates show that savings accumulated by Chinese households during the pandemic are small compared to other countries, mainly due to the absence of government support during the COVID period. These savings, expressed in the form of banking deposits, have been concentrated in relatively well-off households, whose consumption patterns are likely to favour more international travel and overseas spending. Recent data suggest that savings have continued to increase despite the reopening, which shows that Chinese households are still cautious amidst an atmosphere of ongoing uncertainty.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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