This article first appeared in The Edge Malaysia Weekly on July 22, 2024 - July 28, 2024

THE fact that there was disappointment in China’s economic recovery after it reopened post Covid-19 lockdowns and concerns over the impact of its prolonged period of lower growth attests to the significance of Chinese consumption and economic growth to global demand, especially in the decade following the US subprime crisis-induced 2008/09 global financial crisis. Even when China’s gross domestic product (GDP) growth rates came off from as high as 14.2% in 2007 to 9.6% in 2011, they remained above 6% until 2019.

Now, many economies around the world are coming to terms with the fact that they can no longer rely on Chinese consumption to provide a similar-sized extra boost to their exports or tourism receipts as China focuses inward to tackle domestic concerns.

“China is still paying back the 2008 debt — RMB4 trillion stimulus. Debt ballooned, housing prices went out of control and the local government became addicted to debt. China is still paying back all that,” OCBC Head of Asia Macro Research Tommy Xie tells The Edge in a recent interview, adding that it is too costly for China to play “hero” to (rescue or help) global economies.

As China transitions to a more balanced growth model, led by innovation as opposed to pure capital, particularly in the real estate sector, consumer sentiment has been weighed down by the property slump, affecting consumption even as the nation faces disinflationary pressures.

“What matters for China is to not be the next Japan — where the property bubble burst in the 1990s, resulting in a deflationary trap as demand collapsed, referred to as “the lost decades” — and, secondly, is to take care of the welfare of its people. China is in a transition [and] transition is always painful,” Xie says.

The Chinese economy slowed more than expected in the second quarter (2Q2024) to 4.7% year on year (y-o-y) from 5.3% in 1Q2024 on the back of weak domestic demand and the drag in the property market. Malaysia’s advanced 2Q GDP growth is actually higher at 5.8%, improving from 4.2% in 1Q2024. Incidentally, both Malaysia and China’s first-half (1H2024) growth averaged 5%.

External demand helped drive China’s growth in 1H2024, with net exports contributing 13.9% of its growth after contracting 11.4% in 2023. Following the below-expectation 2Q GDP growth numbers for China, some experts have revised downwards their growth estimates for the country to below 5% for 2024 — the official target given by the Chinese government.

OCBC’s Xie, however, kept his full-year forecast at 5% as he thinks that a 5% growth projection still looks attainable at the current juncture. Nevertheless, he highlights weakness in domestic demand as a key concern.

“The problem is there is a gap between the headline number and what people are feeling on the ground, which is the sentiment. Sentiment is weak and that translates into weaker consumption because consumption is a function of three things: income growth, income expectations and wealth effect.”

While income growth has slowed, it remains above nominal GDP growth. However, income expectations have been falling, says Xie.

News of pay cuts and bonus call backs in China’s financial sector has weakened income expectations while the sluggish equity and property markets have resulted in negative wealth effects. Both factors are weighing down domestic demand, as evident in how Chinese retail sales growth for June grew at the slowest pace in the last 18 months, at 2% y-o-y, below May’s 3.7% growth.

In the near term, it seems that consumption will continue to be muted, especially if income expectations stay weak and negative wealth effects continue to linger.

“Right now, we’re seeing consumption — that is government engineered demand from the subsidies given to the consumers. But ‘self-engineered’ [non-stimulus] consumer spending is still on the weaker side. Income growth, income expectation and negative wealth effects are still holding people back from spending,” says Xie, referring to Chinese consumption stimulus that includes trade-in subsidies for cars and home appliances for new energy-saving ones.

To boost consumption in the longer term, Xie believes there is a need to close the wide rural and urban wealth gap. “When you can ensure that everybody is well taken care of, that is good news for consumption. The reason people don’t spend is partially because they don’t feel secure, be it about their retirement, children’s education and so on …  So, this needs to be solved to unlock the growth potential.”

The Chinese government has been pushing for common prosperity or, simply put, the redistribution of wealth, to address the growing disparity between the rich and poor.

In 2021, investors around the world were jittery after the government embarked on a wide-scale Big Tech crackdown that saw big tech companies come under regulatory scrutiny after years of loose regulation. Casualties include the Ant Group, whose planned US$37 billion dual listing in Hong Kong and Shanghai (then dubbed the world’s biggest initial public offering) came to an abrupt halt the week it was set for listing.

Tech companies have been pouring billions into common prosperity initiatives in recent years as a way of “giving back to society”.

Nevertheless, Xie says that the road map to common prosperity is more complex than perceived. “In my opinion, we need to think about how to grow the pie first before redividing it. If it is not done in that order, it could be negative for consumption as well. I think the central government is clear on this but implementation is always difficult.

“For example, growing wages for sectors that are left behind first before cutting the pay for those well-off sectors. People feel like sometimes the sequence may not be right. So that is why everybody feels kind of worst off. I think that is quite detrimental to the sentiment.”

Xie also thinks that there is a big potential for consumption to be unlocked with China’s hukou, or household registration, for people who have moved to the city. He says while the headline urbanisation rate in China is over 60%, the hukou urbanisation rate is low, just over 40%.

He believes that if the government can address this issue, it should give the 300 million people living in the cities assurance and the ability to access social benefits such as housing, education or healthcare.

The slump in the property market, which has gravely affected consumption sentiment, is expected to require more time to reach a new equilibrium.

“The market is still looking for the rebalance of the demand and the supply. We are also seeing rising supply from foreclosures as well because income is affected. So, it will still take some time for the economy to rebalance,” says Xie.

Government intervention in the property sector to slow down the slump may have also inadvertently caused a “slow burn” effect where intervention “may actually have prolonged the downturn”.

“People may not be in a rush to buy now because they have the mentality of whether prices can go down further. I think that is the problem right now,” he says.

Real estate investment fell by 10.1% y-o-y in 1H2024, the same rate of decline as from January to May and slightly greater than the full-year decline of 9.6% last year.

China is facing disinflation, which is opposite to what other economies around the world are experiencing. Disinflation is a decrease in the rate of inflation, with the increase in prices of goods and services slowing over time.

Xie points out that the GDP deflator has been negative for five consecutive quarters, which he says is a sign that disinflation risk is becoming increasingly entrenched. “[The People’s Bank of China] has multiple mandates; inflation is not the only thing to worry about. So, while the inflation rate is very low, the central bank may not be able [to] cut rates aggressively, and this may prolong the disinflation problem too.”

In his July 15 report on China, Xie highlights that the weak inflation print, combined with weak credit growth and money supply, argues for more aggressive monetary policy support. However, the central bank has appeared to prioritise exchange rate stability over interest rates.

“Although the current low inflation rate supports further interest rate cuts in China, concerns about the impact of such cuts on exchange rate stability constrain the central bank’s interest rate policy,” he says, adding that disinflation and exchange rate stability are becoming a dilemma for China’s monetary policy.

Interestingly, he says China’s disinflation has benefited the world at a time when many economies face high inflation.

China has been putting emphasis on its manufacturing sector, especially its high-tech manufacturing sector, in recent years to drive growth. This has resulted in a boost in production and export of goods, which is evident by the 8.6% y-o-y growth in exports for June, above the 7.6% rise in May.

“China is also exporting the disinflation to the world. I think the world needs to thank China because, without China, I think inflation could have been even worse. Chinese exporters are selling goods cheaper this year compared with last year. So, they are making up the loss [in price] by producing more.

“Of course, it’s a double-edged sword. It may affect competitors. At least for now, China’s export of disinflation is good for the region. It’s bad for China, to be honest, but it’s good for the region,” he says.

The tension between the US and China is expected to be the new normal going forward, says Xie. “If it doesn’t escalate, it will just become the new normal. Be it businessmen or consumers, we are all very adaptable and will get used to it.”

In recent times, the US has slapped China with tariffs on various products, some as high as 100%, ranging from semiconductors, electric vehicles, batteries, rubber and surgical gloves, solar cells, to name a few.

So far, Xie says China has withstood the tariffs well, given that the share of the country’s total trade in the world has increased from 13% in 2019 to 14% in 2023. “China is not worse off from the first round of tariffs. But the second round could be a different story — if a blanket tariff of 60% to 100% is imposed. So, we don’t know the consequences [of] that yet.”

Despite all the challenges the world’s second largest economy is facing, both internal and external, Xie chooses to see the glass as half full while being mindful of the half empty portion.

Xie expects China’s GDP to slow a little to 4.6% in 2025 from 5% in 2024, but says its aggressive push in technology-related sectors, which are positive for growth in the long term, has not gone unnoticed. Sectors like electric vehicles, semiconductors and even the low-altitude economy (industries developed from civil-manned and unmanned aerial vehicles that operate below 1,000m above ground) could help to drive Chinese economic growth going forward, says Xie. 

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