China’s economic slump is raising alarm as indications mount that the post-Covid-19 recovery is sputtering. Stimulus that would build on Tuesday’s interest-rate cut is likely coming, but more pain may be needed before Beijing does something big enough to give markets a reprieve and stabilize its economy.
And even then, any relief may be short-lived. Whatever the government does is unlikely to restore China’s economic growth to its previous path.
Beijing is dealing with a shrinking population. Mountains of debt are sitting on the balance sheets of companies and local governments. And geopolitical tensions and a desire to chip away at that debt are making policy makers reluctant to turn to their old playbook of fueling a construction and property boom to revive the economy.
Credit growth weakened in July, the boost in spending that followed the lifting of three years of Covid restrictions is slowing, and there are more signs of turmoil in real estate. Last week, Country Garden, the largest property developer to survive a wave of defaults in the sector in recent years, warned of a record loss. Highlighting the sensitivity of the situation, Beijing has halted reporting of the country’s youth unemployment rate—the latest move in a steady clampdown on investors’ access to data.
“This is just the latest example of China disappearing economic data series that don’t just show weakness, but show weakness in politically sensitive parts of the economy,” said Shehzad Qazi, managing director at China Beige Book, an independent economic research firm. “The youth unemployment problem is bad and is set to get worse,” he said, predicting the youth unemployment rate will rise from its current double-digit levels.
While Chinese officials have stepped up vows to stabilize the economy, efforts so far have been underwhelming. That included the People’s Bank of China’s unexpected move on Tuesday to cut key policy rates related to one-year loans to 2.5% from 2.65%. It was the second cut in three months.
“Cutting rates by 10 to 15 basis points won’t be a solution. It will take at least several months and maybe a crisis or fall in onshore asset prices—like in 2015—before policy makers take [more meaningful steps],” Arthur Budaghyan, chief for emerging markets and China at BCA Research, told Barron’s.
The iShares MSCI China exchange-traded fund (ticker: MCHI) was down 1.5% on Tuesday and off 3% so far this year, compared with the
S&P 500’s
16% gain. The
iShares MSCI China A ETF
(CNYA), which tracks the onshore market, fell 1.2% on Tuesday and is down 5.5% so far this year.
China’s property market, long a critical engine of growth, has been at the center of the country’s economic woes as the government has dealt with the effects of an effort to deflate a property bubble over the past couple of years. Attempts to stabilize the economy more recently by trying to jump-start demand among home buyers haven’t gained much traction, partly because consumers are still skittish.
Beijing’s old playbook for aiding a recovery seems outdated for the challenges of today. In 2015, China leaned on quantitative easing, essentially lending money at very low rates to local governments, who bought homes from low-income people at above-market prices. The condition was that the sellers move into more expensive properties in nearby districts where property companies had built apartments that weren’t selling.
The market wants to see a similar stimulus, but Budaghyan doesn’t expect a 2015-style strategy, partly because that would reflate the property bubble. Beijing is eager to avoid that because surveys show one reason for the low fertility rate is the high cost of housing, and stemming a demographic crisis as the population shrinks is much more important to Chinese officials than near-term economic growth, Budaghyan said.
Equally important is that China has been trying to chip away at the heaps of debt that resulted from its last QE endeavor. Paying down what is owed also would help Beijing put itself on a stronger footing in case international tensions continue to mount, resulting in greater sanctions from the U.S., Budaghyan said.
He sees China’s economy as on the path toward a slow-burn, Japanese-style deflationary situation. But he expects policy makers to do something—perhaps some new iteration of QE that puts money in people’s pockets—to at least avoid severe near-term economic damage.
What that support looks like is unclear, but strategists expect action. When it comes, it could boost beaten down Chinese stocks.
Direct property-focused assistance, such as lowering down payments or relaxing purchase restrictions in second-tier cities, allowing refinancing, or offering funding support for distressed developers could boost confidence among investors and consumers confidence, wrote Solita Marcelli, chief investment officer for the Americas for UBS Global Wealth Management. Her team is sticking with its “constructive view” on Chinese stocks given expectations that more policy support is coming from Beijing, she said in a note to clients.
Budaghyan favors onshore stocks, which he thinks Beijing will support through state-owned banks if things begin to fall apart further. Marcelli favors a diversified approach that includes companies poised to benefit from consumer-oriented support, like online gaming and advertising companies, but that also have more resilient cash flows and aren’t likely to suffer if geopolitical tensions get worse.
The implications of all this go beyond China and its stock market. A weaker Chinese economy and Beijing’s reluctance to rely on construction and infrastructure spending to generate growth also mean less demand for commodities and industrial goods from Europe, Japan, and Australia.
Emerging markets that sell a lot to China, as well as some U.S. companies, are at risk as well. Earlier this month,
Caterpillar
(CAT) executives warned of further weakness from their Chinese operations.
“If China doesn’t buy emerging markets commodities, Brazil, for example, will have less dollars to buy goods from Europe or Japan so global growth will disappoint,” Budaghyan said. “The least vulnerable economy is the U.S. and the U.S. dollar will continue to move higher and keep outperforming the rest of the world.”
Write to Reshma Kapadia at [email protected]
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