A sputtering economy
Recent economic data in China makes for uninspiring reading, according to RBC Global Asset Management Inc. Chief Economist Eric Lascelles.
Housing activity, an important driver of the economy, is struggling. Home sales and home prices have been dropping rapidly as the policies introduced a few years ago to deflate the country’s housing bubble continue to bite. With their primary investments no longer appreciating, Chinese consumers are reluctant to dig into their pocketbooks and retail sales growth has decelerated sharply.
China housing on a downward trajectory
Line chart showing the year-over-year percentage change in home sales and home prices since 2014. Annual price increases were positive starting in 2016, peaking at +8% in 2019. They then started to decelerate and in 2022 home prices started to decline year over year. Prices are now 2% below last year’s level. Home sales activity has been more volatile, with fewer transactions annually until mid-2015, after which transaction volume increased year over year, peaking at +27% in 2016. The increase subsequently decelerated, and transaction volume contracted sharply early in 2020 compared to the prior year. Transaction volume recovered quickly and was up 100% in 2021 compared to the previous year. Home sales activity then decelerated as quickly as it had accelerated. Currently, there are 13% fewer home sales than a year ago.
Note: Home price change is an average of price changes in primary and secondary markets.
Source - China National Bureau of Statistics, Macrobond Financial, RBC Global Asset Management; data through July 2023
Chinese trade is also shrinking. Measured in local currency, or the renminbi, exports are down nearly 10 percent while imports are also falling on an annual basis. Weakness in exports may be the result of tepid global demand for goods, but we think it could also be explained by some countries’ moves to diversify their supply chains away from China at the margin. Meanwhile, soft imports also reflect a weakening domestic environment. Lascelles emphasizes that while China remains a global trade power, trade isn’t driving the economy today (see chart on the next page).
Chinese trade growth decelerates
China trade in goods (y/y % change)
Line chart showing the year-over-year percentage change in goods imports and exports since 1995. Over the last two U.S. recessions (2009 and 2020), both exports and imports contracted sharply before bouncing back. Today, exports and imports are down 9% and 7%, respectively, year over year.
Note: Trade in goods in U.S. dollars. Shaded areas represent U.S. recession periods.
Source - Macrobond Financial, RBC Global Asset Mgmt.; data through Aug. 2023
Much attention has also been given to China slipping into deflation, with July headline annual inflation dipping to -0.3 percent. Though annual inflation in August rebounded into positive territory, to 0.1 percent, the situation remains perilously close to deflationary levels.
Lascelles points out many countries would probably welcome a spell of deflation as it would enable them to claw back some of the crippling price increases they’ve had to endure. But China never had such a sustained inflation spike, so it doesn’t need an unwinding to that extent.
Should a deflationary trend become entrenched in China, it would be cause for concern. In a deflationary environment, consumers and businesses typically delay their purchases as they expect everything ranging from consumer goods to capital expenditure to become cheaper in the future. This serves to weaken the economy, driving prices down even more, as a vicious circle takes hold.
To be clear, a deflationary trend in China has not been established, and Lascelles does not expect one. Still, we think it’s worth keeping an eye on how headline inflation behaves in the coming months.
A measured response?
Authorities are responding to the economic malaise with incremental measures that pale in comparison to the much more forceful approaches taken to deal with past slowdowns. For instance, to mitigate the impact of the global financial crisis in 2008, China launched a stimulus program of more than $575 billion.
Yet, according to Lascelles, authorities are doing a little more than is generally recognized. Below, we highlight some of the main measures announced.
Rate cuts: The People’s Bank of China cut interest rates by 15 basis points on August 15. Given how low inflation is and the economic weakness, one could be forgiven for expecting more dramatic cuts from the central bank. However, Lascelles points out that Chinese authorities are worried about the renminbi depreciating further.
Since mid-January 2023, it has weakened close to 10 percent against the U.S. dollar. Though this may aid the competitiveness of the country’s exports by making them cheaper, China is mindful that it needs a relatively stable currency as it aspires to enhance its status as a global trade power. A widely fluctuating currency could result in buyers of exported goods losing confidence in the prices they pay.
Large currency moves are thus not ideal and authorities are striving to stabilize the renminbi. Yet some currency weakness can be helpful in that it makes imports more expensive, thus helping to fuel some inflation pressures.
Solutions for local governments: Local governments have long been saddled with heavy debt loads. The central government will now allow many provincial governments to issue renminbi bonds to repay problematic off-balance sheet liabilities. In itself, this measure is not enough to solve the local government debt problem, in Lascelles’ view, but it could address the most urgent cases.
Housing stimulus: Having tried to cool the housing market in the past, policymakers are now looking to revive it in pursuit of economic growth. The central government has asked banks to lower mortgage rates for existing mortgage holders. This acts as a rate cut, but not one which weakens the currency. In addition, the minimum down payment ratio for first- and second-time homebuyers will be lowered. Moreover, the four Tier-1 cities (Beijing, Shanghai, Guangzhou, and Shenzhen) have relaxed the eligibility requirements for first-time homebuyers. These are all significant steps, in Lascelles’ view.
Fiscal support for individuals: China will allow additional tax deductions for expenses for child and elderly care as well as for education.
Corporate stimulus: Tax relief for small businesses will be maintained through the end of 2027, and authorities have discussed the creation of a more stable business environment, enhancing corporate governance and encouraging entrepreneurship. There is a degree of skepticism among market participants regarding these measures given the current Chinese administration has not been consistently friendly to businesses. Other measures include the central government cutting fees for stock market transactions and encouraging restaurants to lengthen their hours of operation, and rural regions subsidizing the purchase of big-ticket items.
Hukou reforms: Hukou is a system of household registration used in mainland China. The government tightly restricts where citizens can live, and the system determines an individual’s eligibility for social services such as health care and education. Some of these restrictions are being relaxed, which could in time allocate labor more efficiently throughout the country and improve productivity, according to Lascelles.
Tallying it all up
China seems to be doing more to revive its economy than is generally recognized. Lascelles believes the economy can stabilize from here, though growth may not be as impressive as it had been in the past. Lascelles is now forecasting growth of just under five percent this year, slightly below the consensus. We recommend a Market Weight stance in Asia (ex Japan) equities for global equity portfolios. Such positioning would enable investors to take advantage of Chinese equities’ attractive valuations, in our view, as well as any turnaround in investor sentiment, which is currently very negative and could easily reverse if these policies start to have a positive impact and/or more measures are announced.