China published its second-quarter GDP data on Monday with a big – but disappointing – number, 6.3% growth year on year. The reason for the disappointment comes from the hugely positive base effect, as last year’s second-quarter GDP growth was virtually because of the severe lockdowns happening in Shanghai and elsewhere in the country.
The underwhelming growth in the second quarter is not all about the lack of external demand. Although exports have clearly been hit in June, they had remained rather resilient in April and May. If anything, external demand will become much more of a problem in the second half of 2023 based on June’s data.
The main reason for the poor second quarter, though, is lackluster domestic demand. This is particularly the case for fixed-asset investment, dragged down by the real-estate sector, but also consumption. In fact, retail sales grew even less in June than in March, and consumption propensity remains lower than before the pandemic started.
Given the above, the 5% GDP growth target the Chinese government set for 2023 during the Two Sessions in March will be hard to achieve without stimulus.
This is ironic, since 5% was generally considered too low a target for an economy that was reopening after three years of zero-Covid policies, but China’s new premier, Li Qiang, was already warning during his press conference in March that the 2023 GDP growth target would be hard to achieve, and so it has been.
Against this backdrop, the People’s Bank of China continued to ease monetary conditions in the second quarter, but there has not been any visible impact in terms of credit growth. In other words, the recent cuts in interest rates have not led to an increase in consumption or investment thanks to cheaper borrowing as the borrowing itself keeps decelerating.
Based on Japan’s experience in the 1990s, there is the risk that China is entering a liquidity trap due to the risks of balance-sheet recession. In other words, there is a risk that Chinese corporates and households, pushed by their very negative sentiment about the economic outlook, prefer to disinvest and deleverage in the light of falling revenue generation.
In the case of corporates, this process seems to have started, as profits have fallen substantially in 2023 and Chinese corporates have started deleveraging, especially private ones, and begun to reduce investment.
For households, the growth of disposable income remains stagnant and youth unemployment reached record highs in June at more than 21%.
Why no stimulus?
If monetary policy is not so effective at the current juncture, the question is why a fiscal stimulus – a frequently used policy tool in China – has not yet been put on the table as the easiest solution to China’s economic woes.
Rumours of an imminent fiscal stimulus have been in the market since mid-June, but nothing official has been announced yet. More specifically, such rumours included a one-trillion-yuan package of special bonds to be issued by local governments mainly geared toward infrastructure projects and with the ultimate objective of lifting confidence.
While clearly needed for the now financially weak infrastructure sector, it is not really obvious whether yet one more infra-led package would do the trick of convincing investors that the Chinese economy will return to a faster growth path.
In any event, no such stimulus has been announced, which seems to indicate that Chinese policymakers are still wary about too rapid an increase in public debt, which already hovers around 100% when local governments’ off-balance-sheet debt is also taken into account, in other words the borrowing conducted by local government financial vehicles (LGFVs).
The policy response, so far, seems to lean on easing the regulatory constraints that key sectors of the economy have suffered from in the last few years.
First and foremost, the three red lines that constrained the leverage of real-estate developers were quietly lifted and substituted by 16 easing measures introduced in November 2022. Those 16 measures have now been renewed, which, however, does not necessarily equate to an improvement in sentiment, as investors can see that their impact so far has been muted.
In the same vein, the tech sector briefly felt some relief from the settlement of the open case with Ant Financial through the equivalent of a US$1 billion fine.
The reality is that investors are still wary about the Chinese economy, all the more after the publication of the second-quarter GDP data, and will find it hard to turn their sentiment to a more positive one only by regulatory measures.
The question, then, is whether these poor GDP data will move policymakers toward introducing a big stimulus, not only to be sure that the 5% growth target is reached in 2023 but also to avoid a very rapid deceleration in growth in 2024 once the base effects from the terrible 2022 data are no longer positive.
Two considerations seem warranted when assessing such a possibility. The first is that Premier Li Qiang has been rather silent regarding policy announcements since he took office in March, beyond general statements on how the private sector, as well as foreign investors, should seek opportunities in the Chinese economy.
His behavior needs to be understood in the context of the perceived subdued importance of economic growth in China’s policymaking today as opposed to national-security issues.
Against such a backdrop, a large economic stimulus could be hard to justify, all the more so since President Xi Jinping has long been critical of the 2008 massive stimulus introduced by his predecessors.
The second consideration points to the reduced effectiveness of one more fiscal stimulus, certainly when compared with 2008. Given China’s rapidly decreasing return on assets, an infrastructure-led fiscal stimulus would need to be much bigger to have the same economic impact.
This also implies that, with such a fiscal stimulus, public debt in China would jump well above the current 100% of GDP, which would place the economy among the most indebted in the world.