China, the world’s second largest economy, is going through a difficult economic period marked by the shocks of COVID-19.
The timing is strange considering China is running for the 20th National Congress of the Communist Party in November, which is expected to consolidate President Xi Jinping’s power.
But the problems go beyond the pandemic and specifically include a deflationary asset bubble. Here we break down China’s economic outlook – and what it means for Australia and other countries.
How is China?
The International Monetary Fund (IMF) last month cut China’s GDP growth forecast for 2022 by a quarter to 3.3 percent. This will be the slowest pace in four decades – excluding the 2020 Covid crisis – and well below the government’s target of 5.5%.
In July, almost every data from retail sales and manufacturing to capital expenditure missed expectations, says ANZ chief economist Raymond Yeung.
“My biggest concern is employment,” he says, pointing to youth unemployment in cities at 20%, the highest on record.
Lockdowns to enforce China’s zero-Covid policy aren’t just hampering current growth, Yeung said. Future consumption will also be scaled back as more unemployed youth weaken reliance on China’s real estate market.
Record heat and the worst drought in decades are also contributing to the crisis.
Why it matters to Australia (and beyond).
Australia’s economic fortunes are entangled with China’s, although we have been warned its military threat is the worst in decades.
China is by far Australia’s largest trading partner in both directions, accounting for about a third of all trade. The Australian Bureau of Statistics says Australia’s exports to China (excluding Hong Kong) nearly doubled from imports to $16.3 billion, or about $8.8 billion, in June alone. In January 1988, when the data series began, there were nearly 140 trades.
Before Covid, China rivaled New Zealand as the top source of short-term visitors, reaching 1.5 million in 2019. It catered for about 40% of international students, or nearly twice that of India.
Australia’s trade with mainland China has varied over time.
China dominates global demand for many commodities, consuming 70% of world iron ore exports, much of which is extracted from the Pilbara.
But China’s coal and oil imports are falling, says Laurie Mylivirta, senior analyst at the Center for Research on Energy and Clean Air. “The combination of slowing demand and a push for energy and resource self-sufficiency in China will be a double whammy for commodity exporters.”
Mount pain property
Myllyvirta believes China’s decline in cement and steel production in July is worth watching and coincides with the decline in assets. “Steel recovered but is now falling, reflecting the acute crisis in the real estate sector.”
That pain is becoming more apparent as developers fail and thousands of mortgage holders refuse to pay for homes that may never be built. Illustrative images of the undated demolition are also circulating on social media, as are reports of more than 50 million vacant homes.
The slump in the Chinese real estate market is now so massive and extreme that real estate groups are demolishing entire towns with half-timbered buildings.
— daniel ️ (@danielrembrandt) August 20, 2022
Ironically, Beijing provoked some recession to rebalance the asset-dependent economy. The subsequent halving affected developers like Evergrande, which defaulted on part of its $300 billion ($437 billion) loan.
S&P Global Ratings last week estimated that 40% of developers were experiencing “financial troubles,” with mortgage boycotts bringing both social stagnation and economic risk.
“If strikes are widespread, they could erode financial stability, especially if they cause a sharp drop in house prices,” said Harry Hu, an S&P analyst.
A July S&P report estimated that the boycott could affect loans as high as 2.4 trillion yuan ($500 billion).
Wealth bubble with Chinese characteristics
Michael Pettis, a finance professor at Peking University’s Guanghua School of Management, has long warned of the dangers posed by 30 years of rising house prices.
While China’s economy is about three-quarters the size of either the US or Europe, US wealth has doubled and Europe’s has tripled. The result is both an increased sense of prosperity in China and a gross misallocation of resources.
Pettis recently noted that developers delivered about 40% of the homes they sold between 2013 and 2020 in a relatively good amount of time.
“Property developers have historically relied on rising prices and higher sales to justify massive leverage and more construction activity,” he wrote. “But when the bubble began to burst last year, these heavily indebted real estate developers ran into serious liquidity and credit constraints that made it impossible for them to complete their construction projects.”
Workers in Beijing’s central business district. Michael Pettis believes that China will face a slow pace of growth for a long time. Photo: Wang Zhao / AFP / Getty Images
But while there were “debt disasters” in the US in the 1920s and in Japan in the 1970s and ’80s, Beijing’s control of banks and much of the economy portends a recession rather than a collapse, Pettis said.
“The domestic financial condition is such that there is still no possibility of a financial crisis or a sharp economic downturn in China,” he said. “In my opinion, the country is very likely to face a very long period of Japan-style low growth.”
He said cutting interest rates, including on Monday, is unlikely to result in additional borrowing as households and businesses are servicing loans rather than borrowing more.
Big miners remain optimistic – even though iron ore prices have fallen by a third since April. They are betting on China emerging from recession, as it has been doing for decades.
“We expect China to emerge as a source of stability for commodity demand over the coming year, with policy support gradually clinching,” BHP CEO Mike Henry said last week.
“The Problem of Aging”
Similar to Japan, an aging, even shrinking, Chinese population will add headwinds to the real estate sector and weigh on the broader economy.
China’s population will shrink if it isn’t already. Unravel reported that this would be the first contraction since the Great Famine of the late 1950s. That publication cited the Shanghai Academy of Social Sciences’ forecast of a 1.1% annual average decline after 2021.
If this continues, China’s population will halve from 1.4 billion to 587 million by 2100.
Pedestrians wearing face masks in central Beijing. Photo: Wang Zhao / AFP / Getty Images
However, Jane Golay, an economics professor at ANU’s Crawford School of Public Policy, is wary of “collapsers” who have regularly predicted China’s impending economic demise.
“‘China’s debt seems to be skyrocketing’ — people have been saying that for years,” Golay said. “Eventually it may well happen but I don’t think it will happen this year just because of the COVID zero policy.”
Research on China’s withdrawn one-child policy indicates a decline in fertility over the past few decades accounting for between a third and a quarter of China’s per capita income growth.
“If you stop having children, you reduce youth dependency and thus get an increase in the working-age population,” Gole said. “It increases per capita income.”
He said that raising the retirement age, attracting more women into the labor market and increasing productivity in poor rural areas “could go a long way towards solving the aging problem”.
Golay said that instead of continuing at an 8% annual GDP growth rate, China is likely to remain at an average of 2-3% going forward. “Anything beyond that makes it the largest economy in the world in our lifetime. And that means it’s a force that needs to be counted. ,