Faced with massive opposition for ensuing strict pandemic measures, China decided to refine its rules to prevent the spread of the virus, as well as boost markets and optimism about the economy. Major cities have scaled down mass Covid testing and released people from quarantine camps in accordance with the new guidelines announced last week. Officials have also claimed that further changes are to be implemented in small steps. Optimism that the zero-Covid policy might be relaxed has already fuelled a market rally sending a gauge of Chinese shares in Hong Kong up 17% in the past two weeks. The Hang Seng China Enterprises Index is also now one of the best-performing stock gauges.
However, some may argue that China’s economic woes run far deeper than the pandemic. For the last decade, under President Xi Jinping’s helm, China’s economic growth has slowed down, from an annual GDP of 7.9% in 2012 to 5.8% in 2022. The pandemic merely aggravated the slowdown.
Perennial Problems
Historically, consumption, investment and exports are the three main factors that drive the Chinese economy. However, there has always been an over-reliance on investment and exports, and this approach has negative consequences. Since opening up to foreign trade and investment and implementing free-market reforms in 1979, China has been making significant gains of foreign exchange reserves through export and foreign investment inflow. These ballooning reserves backed the expansion of renminbi liquidity via bank loans. State banks made most loans to either state enterprises or enterprises with good political connections, which then invested all these loans into construction like infrastructure projects, coal plants, steel mills and apartments. In a nutshell, this was what created China’s debt-financed investment, which was also what had spiraled down into the pushback on the economy of China we see today.
China’s credit-boosted economy does not bode well for the nation’s future. While it allowed for dramatic employment and economic growth within China, it also meant that the economy would eventually be left with worsening indebtedness. In the past couple of years, the repercussions had finally begun to surface in China. The problems of unsold residential projects in ghost towns and the unsustainable debt levels of the real estate conglomerates like Evergrande, are among the latest evidence of China’s economic woes. In fact, just this week Evergrande sold a Hong Kong plot at a $770 million loss on one of its most significant assets in the city, in order to repay debts connected to the project. This sale shows the desperation of Chinese property developers to meet their debt obligations.
China was always aware of the issues. However, the magnitude proved too challenging for the government to resolve. Since 1998, the Chinese government realised this investment and debt-driven growth was not sustainable. For more than 20 years, bringing debt under control and boosting household consumption were Beijing’s declared policy goals in a bid to rebalance the economy. When Xi first came to power, his government attempted, with limited success, to restructure the economy by pushing for urbanisation to boost private consumption and a supply side structural reform. Large institutions like banks, real estate developers and local governments, largely dependent on land revenue, prioritised this debt-driven investment growth. This made wealth distribution to the poor virtually impossible. China lacked the political will to favour such redistributions even though that might very well address the problem effectively. Consequently, China’s GDP attributed to household consumption continued to fall to below 40% in the 2010s, from 50% in the 1990s. Total debt share of GDP, on the other hand, soared and is currently approaching 330%, which is among the highest in the world.
China’s current predicament
Today, China faces considerably severe economic problems. Growth has slowed, youth unemployment is at a record high, the real estate market is collapsing, and companies are struggling with recurring supply chain problems. Making matters worse was Beijing’s earlier adherence to its rigid zero-covid policy which had not completely stamped out the virus within the country. The recent outbreak is clear evidence the policy has not achieved its intended goals.
Due to its unwavering stand on its zero-covid strategy, the Chinese government realised it had to step in to alleviate the dire economic situation. Beijing rolled out a flurry of stimulus measures to boost the flagging economy, including a one trillion yuan ($146 billion) package in August to improve infrastructure and ease power shortages. However, downgrades in growth projections of the first three quarters of next year suggest that economists aren’t all that convinced that their stimulus measures can help counter the slowdown of its economy. China’s economy is now projected to grow at 3.5% this year, down from a previous forecast of 3.9%, with growth projections for next year lowered by 0.1 to 0.4 percentage points.
A subdued Chinese economy
Should China resume its strict zero-COVID strategy of lockdowns to contain infections, the economy will only be hit harder with each decision they make to stave off the high case counts. Consumers have been holding off on purchases as the possibility of mobility limits grows, adversely impacting demand. China’s core CPI is now the lowest among major economies, especially with the subdued recovery in domestic demand and is even lower than that of Japan. This has also worsened deflationary pressures. Despite the loosened restrictions, there seems to be a painfully limited number of tools left to engineer the recovery of this embattled economy. In fact, even fewer now that the US is striking right where it hurts, choking access to advanced semiconductor chips in order to circumvent China’s grand plans for hi-tech supremacy.
The property market crisis in China will also be exacerbated if income growth stalls. Property makes up 23% of Chinese production in multiple ways, and 26% of final demand. This may not sound like a frightening number but it is leaps and bounds beyond the underlying income stream to sustain this production level. In other words, should income growth decline significantly and affordability falls, China’s residential and commercial real-estate prices could collapse like dominoes, dragging along the banks, institutions and local governments that have been frantically lending to the sector.
Of course, as daunting as this scenario may sound, we probably won’t experience a bank crash you might expect in a western liberal economy. The Communist Party retains control of the banking systems and legal contracts, thus it can always step in to prevent a disruptive collapse. However, it would unlikely prevent stagnation.
Summing up China’s economic prospect
Given the poor state of domestic demand and a slew of other woes crippling the Chinese economy, deflation is not impossible. The odds of such a situation happening are made even higher with the combined impact of falling energy and commodity prices which could make this a real concern.
But in the meantime, low inflation pressure does signal that there is room for more policy easing. Some economists are optimistic that China’s lingering deflation pressures might force policy makers to review their economic policies again to boost demand. With the recent loosening of its pandemic measures, it appears that China recognises the fact that its economy will suffer if it persists on allowing its political stance to take precedence over its economy. Perhaps Xi might just find a way out of China’s sea of deeply entrenched financial woes.
A Traders’ View
As the world battles with the uncertain and unpredictable market, global rise in inflation and interest rates, and deflating of liquid asset prices, many traders and investors are bracing for a full-blown financial crisis. Throughout my years of research and study of the financial markets, there are a few “safe” assets one can invest in as a hedge against financial crisis. Historically, Gold is the one that has stood the test of time. Investing into Gold can be complex, especially in the current high and rising interest rates environment. Anyone who invests in Gold must have a good understanding of employing hedge in their investment portfolio
The above chart is the recent price movement of spot Gold(XAUUSD), as we can see here, XAUUSD price has corrected close to 20% from its recent high of 2070 for the past 8 months and this is because of the rising US Fed Funds rate since March.
US CPI and PPI in November registered a lower than expected figure. The fed funds rate is currently at the higher end of the Fed’s dot plot, indicating that the US Fed could be nearing the end of its rate hike. In anticipation of the global uncertainties and possible Fed’s ending of rate hike, I would expect the Gold price to revisit the all-time high of 2070 or possibly break the all-time high by June.
