After a disappointing reopening following the end of the zero COVID-19 policy, China’s economy has been in the spotlight, with many market participants showing a high degree of pessimism about the short-term outlook of the economy. However, over the past few weeks, the deterioration in the macroeconomic indicators that we have seen since early April has halted, with recent data hinting at a bottoming-out of economic activity. This seeming recovery has ultimately culminated in the publication of the GDP figure for the third quarter of this year. According to official statistics, the Chinese economy expanded by 4.9% in the year to 2023 Q3, higher than market expectations of an increase of 4.5%. The quarterly figure stood at 1.3%, up from a downwardly revised 0.5% in the previous quarter. With September data pending, Fathom’s China Momentum Indicator, a high frequency proxy for GDP growth in China, also points to a stabilisation of activity.
To gauge the magnitude and direction of the recent positive developments in the Chinese economy, it is necessary to look carefully underneath the surface. Domestic demand shows some positive developments — on a three-month annualised basis, and adjusted for seasonality, retail sales growth in September turned positive for the first time since May. By categories, the main driver was restaurant sales, indicating that consumers have a preference for spending on services following three years of lockdowns, while spending on durable goods, such as automobiles, remains weak. However, regardless of whether short-term developments continue to be positive, the outlook for Chinese consumers does not seem very flattering going forward. Confidence remains at historical lows, impeded by a weak housing market, and the absence of government policies targeted at rebalancing the economy and improving income redistribution will continue to keep private consumption subdued.
Given that the turnaround in private consumption has occurred only at the end of the quarter, the surprising positive GDP figure may have come as a consequence of higher investment, the main engine of Chinese growth. This seems to be the case, as China credit impulse troughed in July and has been rising quickly since then, mainly driven by the grant of new loans and a higher government bond issuance. Nevertheless, credit for the Chinese economy is a double-edged sword – while it can stimulate activity in the short-run, it delves into the structural problem of over reliance on credit. Furthermore, Fathom finds that this credit is increasingly getting ‘less bang for its buck’. The Chinese state has been pouring money into the economy for years, especially the real estate sector, and Fathom’s analysis shows that a large share of this investment has been channelled into unproductive activities. Over time, the efficacy of this debt-fuelled approached to growth has diminished. In 2002, every additional CNY 10 of credit poured into the economy used to generate CNY 2.1 of output, but today it would only generate CNY 0.2.
Finally, the outlook for the external sector does not seem to show clear signs of recovery. Although monthly export growth has turned positive since August, a slowing global economy and ongoing geopolitical tensions with the US should continue to paint a gloomy picture for China exports going forward. And, most importantly, we should not expect exports to drive economic growth in China – as Fathom research shows, exports are no longer the boon they once were, having decreased their importance, with growth now around 5 percentage points, due to a structural fall in demand for Chinese products.
Going forward, short-term developments should continue to point to a stabilisation of economic activity, especially helped by the fiscal stimulus package that was recently announced. However, it is still too early to call for a recovery in China’s economy, much less forecast an acceleration in economic growth from now on. The economy still faces very important cyclical and structural headwinds, something that appears to be of special concern to President Xi Jinping, who visited the PBoC for the first time ever this week. These vulnerabilities, notably the real estate downturn that the country is currently experiencing, could provide market participants with unpleasant surprises and turn their optimism, again, into a big disappointment.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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