FOLLOWING the sudden lifting of Covid restrictions at the end of 2022, the Chinese economy had a strong rebound early this year; but the growth momentum quickly lost steam after the initial surge.
The manufacturing Purchasing Managers’ Index (PMI) dropped into contraction territory in April, and there was a broad-based weakening of most economic indicators in the following months.
Almost every country in the world has experienced a post-Covid rebound, but why did the recovery in China lose momentum so quickly when – as suggested by weak inflation – there is still a lot of slack in the economy?
Waning global demand is one reason. In our view, however, China’s weakness is not mainly export-led, but instead lies more in its soft domestic demand.
What, then, are the reasons behind the country’s weak domestic demand?
An important point to note is that between 2020 and 2022, Covid was not the only shock to hit the Chinese economy.
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In August 2020, the Chinese government imposed new policy guidance on selected property developers to limit their leverage – the so-called “three red lines”.
The scope of this policy widened in 2021, and eventually led to a sector-wide credit crunch and a hard landing in housing-related activities.
Housing sales and property investment both fell by double-digit percentages, and many developers defaulted on their debts.
In late 2020, the Chinese government also launched a regulatory campaign against some large Chinese Internet companies – starting with the e-commerce giant Alibaba.
Then, in mid-2021, the government cracked down on the private-tutoring industry.
Lifting Covid restrictions, although a major positive, therefore proved to be insufficient to lead to a sustained rebound of the economy.
Among these shocks, the hard landing of the housing sector probably caused the greatest damage.
It is hard to overstate the importance of the housing sector to the Chinese economy. Real estate development accounts for only about 7 per cent of China’s GDP, but its overall importance is much larger. This sector is connected to many other parts of the economy: mining and materials in the upstream, and home appliances and various services in the downstream.
It is widely estimated that property-related activities contributed to about 30 per cent of Chinese growth over the past decade.
Local governments also have a high dependence on the property sector – through land sales, which at a point accounted for more than 30 per cent of local public revenue, and partly funded the rapid growth in infrastructure investment for many years.
There might be good reasons behind the Chinese government’s determination to rein in the property sector – such as the change in long-term demand and supply dynamics in the housing market, and concerns about some developers’ excessive leverage.
Yet, the almost instantaneous shutdown of a main growth engine in a US$18 trillion economy obviously caused a lot of damage.
Apart from the credit crisis among the real estate developers and associated bond defaults, jobs and incomes were lost. This, in turn, hurt consumption.
More importantly, the decline in prices for housing, which form the bulk of Chinese households’ assets, has shifted people’s expectations and resulted in greater precautionary savings.
What to expect
Our observations suggest the top decision makers in China may refrain from strong and broad-based stimulus in the near term, due to the concern that ballooning public debt will create even bigger problems down the road.
We expect more policy support in the near term; but the measures will likely continue to be piecemeal and targeted, and of a fairly modest magnitude.
This means that the trajectory of economic recovery in China will likely be even flatter and longer. We recently revised down our full-year GDP forecast for China in 2023 to 5.2 per cent – from 5.5 per cent previously – which is slightly above the government’s target of 5 per cent
Outlook for Asian assets
The performance of Asian equities has lagged this year, in large part due to the slowing momentum in China.
Equities in China, which carry low valuations, could benefit from policy stimulus in the months ahead; and earnings-per-share prospects are good.
Valuations are low in the rest of Asia too, even though economic growth is holding up well in countries such as India.
Japan is also a part of the Asian growth story. Japanese stocks have already had a good run – the Topix is one of the best performing indices in local-currency terms this year, thanks in part to a weak yen.
Still, we believe governance reforms, low valuations and the diversity of the Japanese equity universe could keep investors interested.
India also stands out when it comes to bonds, with hard-currency corporate bonds there performing strongly in the year to date.
The picture has been more mixed for Chinese high-yield, with more support needed to restore confidence in the property sector and broader economy.
Within a neutral stance on hard-currency emerging-market bonds overall, we continue to favour investment-grade Asian corporate bonds.
The writer is head of Asia macroeconomic research at Pictet Wealth Management
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