Commentary: China’s economy will probably get worse before it gets better
A promising surge in consumer spending over the Chinese New Year holiday doesn’t give Beijing any guarantees about an economic rebound ahead of its annual Two Sessions meetings, says Natixis economist Gary Ng.
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HONG KONG: China was surely hoping to start the year off strong, looking to the massive Chinese New Year holiday for signs of economic recovery, especially ahead of its annual Two Sessions meeting starting on Mar 5 where the government will announce its growth target for 2024.
With annual exports falling for the first time in seven years and investment dragged by the property turmoil in 2023, consumption has become the key in stabilising China's economic growth.
Official data showed a promising surge over the eight-day holiday, when hundreds of millions of Chinese returned to their hometowns or indulged in domestic tourism. Domestic trips and tourism spending exceeded 2019 pre-pandemic levels by 19 per cent and 7.7 per cent respectively.
Unfortunately, it will not be that easy to solve China's woes. There is no solid evidence of improving consumer confidence.
LISTEN: China correspondents Olivia Siong and Low Minmin talk about the potential items on the agenda for the nation’s most important political event of the year – the upcoming Two Sessions meetings.
NO SIGNAL OF A FULL REBOUND
Consumers spent less during the holiday this year with the average spending per trip down 9.5 per cent lower compared with 2019. The spending pattern showed consumers remain cautious about the economic outlook: More may be more willing to spend money on travelling and services as well as potential frontloaded purchases due to the holiday season, but they were not exactly loosening the purse strings.
There is no guarantee the rebound will last, nor has it been big enough to offset the sluggishness of big-ticket items, such as automobiles.
The Chinese economy now relies more on consumption as income has risen with a growing middle class, after a series of transformations from the export-driven growth model following its accession into the World Trade Organization to the investment-led model in infrastructure and real estate built on leverage.
But consumption still suffers from deceleration due to fading “animal spirits”, a term economists use to describe the sentiment and future expectations that drive consumers' decisions. Households typically spend more and reduce savings when they feel optimistic about the future - a scenario that contributed to soaring inflation in many economies in the last few years.
DISINFLATION WILL BE THE NEW NORMAL
China is now facing the opposite problem - cautious consumers amid deflationary pressures. The last reading of a People's Bank of China survey showed that 58 per cent of depositors wanted to save more in June 2023, higher than 45 per cent before the pandemic started.
Stripping out the more volatile food and energy prices, China's consumer price growth has declined from above 2 per cent on average in past years to 1.5 per cent in 2024, based on data from the National Bureau of Statistics of China.
With the rapid adoption of industrial reboots and digitalisation, China has cut costs in many aspects. The still weak sales also put producers and retailers under pressure to keep prices low. With supply recovering faster than demand, it is possible to see China exporting the overcapacity to the world and increasing competition.
The disinflation will hurt the middle class the most as they are estimated to comprise 30 per cent of the population but around 50 per cent of total consumption.
With greater exposure to mortgages than the lower-income group, disinflation and slower income growth mean the middle class will face higher real interest rates. The wealth effect will also be more limited through the pressure on passive income and asset appreciation, such as equities and properties.
Such loss of animal spirit can fuel a change in consumption patterns and limit unnecessary spending. Unless the demand is exceptionally robust, the current consumption trend may not be strong enough to pull China out of disinflation.
WAY OUT FOR CHINA?
There are expectations for the Chinese government to do more to boost the economy.
Its focus can be on more than supply-side support, such as boosting manufacturing capability. Demand-side policies, such as tax incentives for durable consumer goods and lowering costs for households, can stimulate consumption and keep up the economic momentum.
Improving confidence is essential, but that is easier said than done. The household perspective often takes time to respond to policy changes and economic data.
For example, new home sales have hovered at 50 per cent of the average of 2019 to 2021, the level before regulatory changes, despite laxer policies introduced to avoid the collapse of indebted property developers, such as Country Garden. It is difficult to repair the damage to confidence, and the government could be finetune regulations on a greater scale.
There is also the challenge of China’s increasing trade-off between security and economic growth. Easing geopolitical tensions would help households reduce future uncertainty, improve the export-driven provinces' economies and attract foreign investment into China. But this seems an unlikely bet.
If hopes are pinned on consumption to drive China’s economy recovery, it will ultimately depend on the revival of animal spirits and restoring households’ optimism about the future. This will take more than an upbeat start to the Year of the Dragon. China’s economy will probably get worse before it gets better.
Gary Ng is senior economist at Natixis and research fellow at Central European Institute of Asian Studies (CEIAS).
