Checking in on China
Whilst the world is engrossed with the bloody war in Ukraine one of the main engines of world growth is sputtering badly, away from everyone’s gaze. China is currently struggling with several issues that need to be unpacked to see what damage can occur: the currency has suddenly started depreciating rapidly; there are Covid lockdowns in the major metropolises and there are growing fears of the consequent effects on production and supply chain disruptions; even the financial system and the housing markets are in disarray.
Fig. 1: The Yuan that’s getting away
Source: Investing.com
Firstly, from the graph above we can see the rapid depreciation of the Yuan against the US Dollar. The Yuan, which had hitherto been appreciating steadily against the greenback for the last 12 months, suddenly reversed course and undid the whole move in 5 trading days this month. Much of this is due to the opposite end of the monetary cycle to everyone else that China finds itself in- going into 2022 with an easing bias versus the global push to higher rates to counter rising inflationary pressures. The Central Bank has been injecting liquidity through eased reserve requirements and- combined with the fact that the Federal Reserve in the United States could be at the start of a series of 50 basis point hikes, has jumpstarted the Dollar against the Yuan. Chinese 10-year government bonds now offer no premium yield over the same tenor US government bonds. Though many currencies are facing the same resurgent dollar the Yuan moves in a far more calibrated and incremental manner and this sudden weakness has caught China analysts off-guard and sent a negative signal to the outside world.
Part of China’s troubles are self-inflicted; they had successfully combatted Covid-19 even though it originated there, and they had to deal with an unknown deadly virus. But now that it has largely mutated to a more virulent but far less deadly strain China is still enforcing lockdowns with the same zeal as before. Most countries have now accepted that the virus is endemic, and China’s lockdowns seem counterproductive. Indeed, with the spread of the virus much more prevalent than in the first wave, China has imposed lockdowns on over 20 provinces which account for over three quarters of China’s GDP in their zero Covid goal. It goes without saying that this will impact GDP growth significantly the longer and more widespread this policy is implemented. The near-term outlook for GDP growth is already weak and Chinese PMI (both manufacturing and services sector) has been on a sharp downtrend and the numbers for March had already showed them to be in contractionary territory (below 50); April’s number promises to be worse still.
The attempts by the Chinese government to counter these macroeconomic trends include the monetary measure highlighted earlier but also- just announced yesterday, the Central Finance Committee, headed by President Xi himself, includes fiscal support for key infrastructure projects- read construction and includes spending on airports, transportation hubs and energy and water conservancy projects.
The Chinese property market is in some degree of trouble but at a less visible level. There is a lot of distress in the markets after the Evergrande crisis of last year which saw the largest property developer in China default on its bond coupon obligations. Whilst $19 billion were owed to overseas investors Evergrande had total debt obligations of over $300 billion. The debt overhang that is impacting construction is what the government is trying to address but it cannot immediately help the wealth erosion that has occurred for millions of citizens in the 3rd and 4th tier cities of China which have seen falling prices for 7 months in a row. This is being masked to an extent by rising prices in Tier 1 and Tier 2 city house prices, but this will be a blow to the already brittle consumer confidence of the middle class given that these Tier 3/4 cities account for 300 cities, 2000 town/ cities and about 40,000 towns. Outstanding mortgages in China stood at $6.1 trillion dollars at the end of March and the pain is widespread over a vast geography.
The only upside for the world of China facing cooling demand internally is the unusually large volumes of metals they have been exporting because of the build-up of inventory following a slowdown in construction. Aluminium, copper, and Zinc are being exported at record volumes and will help cap prices globally. Whether this sustains in the wake of the Central Finance Committee’s decision to increase spending in construction now remains to be seen.
In another seeming self-goal China instituted a crackdown last year on ‘big-tech’ as part of a broader social programme to redistribute the benefits of wealth internally. The share prices of those firms have yet to recover. Similarly, their political stand-off with the United States is taking on a multi-dimensional range: trade tariffs and unresolved disputes plague the commercial zone, concerns about cyber-security affect the roll-out of 5G technology, the formation of AUKUS pact and the Quadrilateral Security Dialogue meant to exclude and stand up to China are also thorns in the relationship that China and the US now have. China’s backing of Putin was telegraphed months earlier when they refreshed their treaty of friendship last year but this commitment may now bring them in the line of secondary sanctions from the US.
In a way, China’s relationship with the United States is symptomatic of the uncertain nature of the world today. As we exit a global pandemic and face the consequences of the emergency and untested policies enacted to deal with it, we’re entering a new scenario with more global animosity, less trust, more barriers, new alliances, and a different outlook. As soon as we normalise this situation, we will come up against the very real climate crisis that we have staring us in the face. The world needs Chinese cooperation in the economic, political and climate change crises upon us. Whether they have the bandwidth to deal with it now is a different matter altogether.