China Outlook: Slowdown, As Policy Stimulus Not Enough

Our Forecasts

Source: Continuum Economics

Policy Stimulus Insufficient to Stop Slowing 

Our GDP forecast looks for a slowing to 4.0% in 2024 from 4.8% in 2023 for a number of reasons.

• Property construction downturn. The negative drag from the decline in residential property construction is set to continue (Figure 1). Property developers are in crisis with lower than pre pandemic sales, banks and investors less willing to lend to developers and households reluctant to pay upfront for new builds. The problem is the most acute in tier 3 and 4 cities given the overhang of excess inventory and the slower population growth than tier 1 and 2 cities (here). This produces a cascade of negative drags on the economy in terms of negative residential property construction; less construction employment; lower demand for cement and steel; weak furniture sales; lower taxes for local government and LGFVs.

Figure 1: Cumulative YTD Million Square Meters Residential Real Estate Development Versus Investment in Real Estate Development (%)

Source: Datastream/Continuum Economics

• Infrastructure and exports not strong enough. China has resorted to infrastructure investment, which helps to counterbalance the drag from lower residential construction. However, private companies remain reluctant to aggressively increase investment plans, as the relaxation of the previous crackdown on entrepreneurs has been insufficient. This leaves a lot of burden on SOE and LFGVs, but some have problems of their own and the government has announced Yuan 1-1.5trn debt swaps for the weakest LGFVs (here). Net exports are also not sufficient to boost overall GDP growth, as the Yuan decline is only modest and weak growth in the world economy is more important. China exports are also starting to suffer from a shift from China centric supply chains to have some supply chains in Mexico/Europe.
• Consumer spending has been divergent with services helped by tourism and eating out but goods have seen slowing growth. The post COVID boost to certain retail sales sectors will likely continue in H2 2023, but then the prospect is for slower consumption growth in 2024. Also a structural issue is that precautionary savings are high due to insufficient state provision of childcare, education, health and pensions. While some recent measures include extra help for childcare, President Xi has previously rejected the European welfare state model. The structural slowdown in labor force growth with population aging makes matters worse. With caution also on a cyclical basis due to the residential property downturn this means that consumer spending is set to slow into 2024. 
• Targeted rather aggressive policy stimulus. Policy stimulus has been measured over the last couple of months, rather than aggressive as occurred in 2009/2015 or 2020. The July Politburo meeting rhetoric has not been matched by action, though a further 0.25-0.50% of fiscal stimulus could still arrive. Meanwhile, financial rescues have focused on forced mergers of weak banks (here) or the restructuring of shadow banks and property developers (here), with occasional guidance to avoid default of key players. At one level, this is balance of policy stimulus with emerging problems. However, we also think that China authorities are reluctant to aggressive stimulate the economy, as it concerned that the overall level of debt is too high (here) and could risk a balance sheet recession that causes years of weak growth. Thus targeted rather than aggressive policy stimulus will likely extend into 2024.

Figure 2: Scenario Analysis for China Debt Overhang(%) 

Source: Continuum Economics

Overall, H2 2023 will likely see a slowing of quarterly GDP pace relative to H1, as the property sector hurts the economy and Q3 could be weak (0.5%) before the targeted policy support helps Q4 to around 0.8% on the quarter. The quarterly growth profile will likely improve marginally in 2024 due to the recovery of the global economy, but will still remain below 5% growth per annum. Given that additional policy measures will only be targeted, the negative drag from the residential property sector will remain; additionally, considering the restraint on other major parts of the economy, we forecast 4.0% GDP growth in 2024. Downside risks surround the baseline forecast, as the property market decline could be larger than we anticipate. This could bring in renewed adverse economic headwinds. As we highlight in our scenario analysis piece on China debt hangover, the main alternative scenario is for a hard landing of the economy into 2024-25 that brings growth down to the 1-3% area for China (here) – we also increased the probability to 20-30%.Apart from 2020, such a hard landing has not been seen since 1967/68 and 1976. We also reduced the 2023 and 2024 CPI inflation forecasts to 0.4% and 1.0% in between Outlooks given recent downside surprises (here). Low inflation numbers on a Yr/Yr basis will likely last for a few more months, but this is not deflation. Core inflation shows that the prospect remains for a swing back to small positive inflation in 2024, but this will remain well short of PBOC’s desire for 3% inflation.

Policy 

All of this means that more policy stimulus is required and we have brought forward an additional 20bps of MTF cuts from 2024 into Q4 2023 (here) and a further 25bps RRR cut for November. We then have penciled in a further 10bps cut for Q1 2024. The PBOC could in theory cut interest rates still further and launch a QE program, as more aggressive monetary policy moves. However, we feel that the bias will be towards using quantitative guidance to the banking sector to sustain loan growth above 10%, as this is more direct and quicker to impact than aggressive rate cuts or QE – the latter could also be seen to be against the idea of common prosperity, given the inequality increases in DM countries since 2008. This increased lending can be directed towards LGFVs and SOEs, especially if, as it seems likely, private business and households are not looking to increase lending on the scale required by the authorities. The 19 systemically important banks can support lending provided that the authorities are proactive in resolving/forcing takeovers for weaker financial institutions, while China has a lot of experience in bank rescues (here). This can help support growth in 2024, though does not really boost growth given the cautious attitude in the private sector.

China authorities will likely also accept a slow decline in the Yuan in the coming months. The USD is strong across the board and interest rate differentials suggest that the Yuan could weaken further (notwithstanding capital controls). We would see recent FX intervention as being an attempt to pause the Yuan decline rather than stop the fundamental adjustment. However, China authorities remain opposed to a more substantive devaluation as it could trigger capital outflows and upset China’s households, which could cause domestic political pressures.