Economy of China

1. Long-term trends 

In recent years, China's rate of growth has surpassed that of other nations with comparable levels of development. Since 2000, there has been an average GDP growth surpassing 8% annually, leading to significant improvements in living standards and the near eradication of extreme poverty. Because of the combination of two factors - double-track and gradual trade liberalization, China has emerged as the second largest economy in the world in terms of dollars and the largest in terms of purchasing power parity. China is responsible for the biggest share of worldwide economic growth and makes up around 33% of the overall growth.

Frequently, quick expansion comes with the development of disparities. The significant savings of households, attributed to low private consumption, have been utilized to fund investments in real estate and infrastructure, leading to reduced yields. This also led to increasing imbalances seen in the debt burdens of both property developers and municipal governments. The lack of balance and the decrease in economic productivity limit the potential for additional expansion.

The real estate industry makes up roughly 20% of the GDP, leading to potential economic slowdown and risks to macro-financial stability in the event of a sector downturn. Authorities must work to mitigate these adverse impacts. Limitations on credit financing in the real estate industry have caused a 25% decrease in real estate investment, reduced land sales and housing launches, and posed challenges in finishing current projects, ultimately diminishing buyer trust. This has put more strain on the finances of local governments (as a result of less income from land sales for building, decreased tax earnings, and increased expenses for the residents).

Another issue in China is the elevated rate of unemployment among the youth, peaking at 21.3% in June 2023.

 

The growth rate of real GDP in 2023 was 5.2% (year-on-year), the lowest since 1990. Most of the growth was attributed to a rise in consumption as a result of pent-up demand from the period of covid closures. The savings rate within households has dropped back to levels seen before the Covid-19 pandemic.

China's economy exceeded expectations by growing 5.3% year-on-year in the first quarter of 2024, surpassing the predicted 5.0%. This was the fastest expansion since the second quarter of 2023, driven by ongoing government aid and expenditures connected to the Chinese New Year festivities. Fixed asset investment increased by 4.5% in the initial quarter of 2024, the highest growth rate in nearly a year, surpassing the projected 4.3% rate. China experienced a moderate 5.10% increase in manufacturing output in March 2024 compared to the previous year. China's manufacturing production saw an average annual growth rate of 6.62% between 2013 and 2024. Retail sales increased by a smaller margin than anticipated. At the same time, the unemployment rate was at 5.2% in March, staying close to February's 5.3% which was the highest in 7 months.

In March 2024, China's exports decreased by 7.5% compared to the previous year, totaling $279.68 billion, exceeding the anticipated 3% decrease according to market predictions. In the month prior, there was a 5.6% increase in growth. The drop in exports occurred during a stronger March last year, which saw a 10% increase. Exports increased by 1.5% year-on-year to $807.50 billion in the first quarter of this year. Total exports in the first quarter saw a significant decrease to the European Union (-5.7%), South Korea (-9.8%), and Australia (-8.9%), and a smaller decrease to the United States (-1.3%) among trading partners. Simultaneously, there was a 4.1% increase in supplies to Southeast Asian nations. An increase in exports to Vietnam (18.5%) balanced out decreases to Singapore (-7.2%) and the Philippines (-14.4%).

In the third quarter of 2023, public investment growth surpassed 10% year-on-year, contributing approximately 2 percentage points to the 5.2% GDP growth. Private investment stayed mostly unchanged, with robust growth in manufacturing, technology, new energy vehicles, and climate-related industries balancing out a decrease in residential investment.

 

Based on the current patterns of urban household growth and predictions about the retirement and replacement of housing stock, it is anticipated that the essential need for new housing will decrease by nearly 50% in the next decade. Decreased demand will make it harder to solve the issue of excess supply, impacting the secondary market, slowing down the correction process in the near future, and decreasing economic growth rates. Simultaneously, there could be an even more significant decrease in demand in certain areas.

The decrease in housing sales is mainly due to the absence of price adjustments, with house prices dropping by just 3% in 2023. Prices are still elevated compared to both personal income and rental rates. China's biggest real estate developer, Country Garden, has recently defaulted, leading to a worsening of financing conditions in the industry and causing an increase in unfinished construction, which has further dampened homebuyers' expectations. Simultaneously, the increasing overdue payments have had a negative effect on the finances of local governments.

 

The government has implemented several measures to stabilize the real estate market: boosting lending for housing completion, widening eligibility for housing purchase benefits, reducing payment requirements, relaxing conditions for refinancing mortgages, and decreasing interest rates for the secondary market. Measures have been implemented on the supply side as well, including lowering risk coefficients for banks providing funding for developers' building projects, supporting the affordable housing sector, and upgrading housing in rural areas.

 

Following a temporary increase due to the resolution of supply chain issues in the first quarter of 2023, Chinese exports fell due to lacking global demand. Imports followed the same trend as domestic demand, decreasing in mid-2023 and then bouncing back by the end of the year. The deficit in services expanded as outbound tourism slowly recovered, but it still did not reach pre-recession levels. In 2023, the current account surplus dropped to 1.5% of GDP, a decrease from 2.2% of GDP in 2022.

 

In the high-performance microchip industry, China enforced export limitations on gallium and germanium in August and December 2023. The limitations also impacted the graphite necessary for making batteries for electric vehicles. The mining and processing of these minerals are mainly done in China, and any limitations could have a global effect on semiconductor and electric vehicle manufacturing. China reacted to an embargo on semiconductor exports by taking action that harmed its industrial sector. Trade restrictions in the U.S. have increased, leading to a decrease in Chinese exports to the country.

Capital outflows in 2022-23 were driven by the varying percentages between China and other major economies, worries from investors about China's future growth, and increasing geopolitical dangers. By November 2023, around $6 billion had flowed into equities in 2023, with bond outflows totaling $87 billion. During the third quarter of 2023, inward foreign direct investment reached its lowest recorded value at -0.3% of GDP. In 2020-211, additional investments helped balance the surplus in the balance of payments. In 2022 and the first half of 2023, there were net inflows as residents withdrew overseas assets they had accumulated.

 

The exchange rate is under more pressure due to different monetary policies between the US and China, and pessimistic investor views on China's economy. The offshore yuan is nearly 6% less expensive at the end of April 2024 than it was at the start of May 2023. With moderate inflation, the yuan is experiencing a genuine decline. In the midst of these developments, the government set the exchange rate higher than what the market had anticipated. Moreover, in order to prevent the excessive devaluation of the yuan, the stipulations on foreign exchange reserves were decreased and the restrictions on cross-border capital flows for financial institutions and enterprises were strengthened.

 

The financial sector's vulnerability is at a relatively high level in 2023, with an increase in credit risks, a decrease in banks' profitability, and a decline in asset quality contributing to its weakness. Reduced interest income at banks was caused by monetary policy adjustments, lower demand for mortgage loans, increased early mortgage repayments, and administrative efforts to lower mortgage rates, while deposit costs rose due to a shift toward term deposits by households.

The decline in the real estate market, combined with losses in the service sector due to the COVID pandemic, caused a deterioration in the quality of banks' assets. The highlighted patterns particularly impacted small banks that have restricted capital reserves and liquidity buffers.

Credit risks stem from challenges in funding local governments, as their revenue is heavily reliant on land sales for growth.

 

In 2023, the overall debt to GDP ratio saw continued growth following a brief period of stabilization before the onset of the covid pandemic. In 2023, the IMF reported that quasi-public debt was equivalent to 116% of GDP. Local budgets contributed significantly to the growth in 2023 (+6.2 pp), whereas the central government debt only rose by 2.3 pp compared to 2022. There was a significant rise in corporate debt in 2023, increasing by 4.7 percentage points of GDP, while household loans decreased.

 

Global inflation increased to over 7% on average in 2022. Inflation remains well above the target level in most countries despite the global decrease in inflationary pressures in 2023. Given this context, inflation in China remained relatively low, with core inflation being the least among G20 nations. One of the main reasons for disinflation is a decrease in economic activity. The delayed easing of restrictions after Covid and the slow pace of economic recovery are said to be the reasons for the negative output gap in China.

Another factor that contributes to lower inflation is the restricted impact of food and energy price changes on local prices, mainly because of government control over prices of essential goods.

Various estimates indicate that the rise in housing prices contributed to a 0.6 percentage point increase in inflation in OECD countries. The rise in rental costs was caused by escalating house prices resulting from numerous support measures implemented during the Covid-19 pandemic. In China, the decline in the real estate industry led to lower real estate prices and rents, thus negatively impacting inflation.

      

 

IMF predicts a slowdown in Chinese economic growth to 4.6% in 2024 due to ongoing real estate sector problems affecting private demand and business forecasts.

In 2024, the pace of consumption growth will decrease in comparison to the year of recovery in 2023. Public spending will stay at an elevated level.

Although there has been a small improvement in external demand, it is predicted to stay relatively low in the foreseeable future. As per the IMF prediction, the current account surplus is expected to stay at 1.3% of GDP in 2024, with export recovery being balanced out by rising outbound tourism and the return of external investment income to pre-crisis levels.

In spite of the anticipated deceleration, there are expectations for the output gap to decrease and for core inflation to rise steadily to reach 1.4% by 2024.