In the global struggle to regain lost economic momentum in the aftermath of the Covid pandemic one of the main engines for world growth- China, is suffering from a troika of troubles that threatens to make it the wheel that falls off. The woes that are ailing China come at a particularly bad time for the Chinese leadership as they stand ready to confer in October an unprecedented third term as leader to Xi Jinping. Will the troubles facing the economic giant lead to further instability in global economic recovery? Will it lead to political uncertainty within China that could have worse consequences for the rest of the world as China flexes its territorial ambitions? Either way, this looks like a rather pivotal moment in time for China.
We can do a quick recap of China’s problems: the Covid pandemic may be over but the precautionary fear that led to China being able to manage with a minimum number of cases and deaths proportionate to the rest of the world has not left it. There has been a series of rolling lockdowns that affect city after city for months at a time. Just as one city or region eases restrictions, another gets affected or extends theirs. Currently, just as Shenzhen has started easing restrictions another city- Chengdu with 21 million inhabitants, has extended theirs. This draconian zero-tolerance policy has the backing of President Xi himself. But is it a case of overkill? Since late August, Shenzhen, a city with nearly 18 million people, has registered a total of about 500 cases and zero deaths. Shanghai endured a two-month lockdown. What is it doing to economic output and morale amongst the people will become evident as the data rolls in. But it has made China GDP growth targets for 2022 unachievable.
If it weren’t for the Covid lockdowns then it would be the property crisis that has been spreading through the country that would have brought down Chinese growth. It may not be popularly known but the Chinese property market is the largest single asset class in the world- larger than the US equity market. Taking into account the final demand that it accounts for in the Chinese economy (both direct production value and indirect demand it generates and connection to other sectors including the finance sector, the real estate sector, in trade and basic metals, capital goods) Caixa Bank research estimates that it has an ‘importance’ of about 24% of the country’s GDP. About 70% of the country’s household wealth is stored in property, along with 30-40% of bank loan books, while land sales account for 30-40% of local government revenue, according to Pantheon Macroeconomics. A self-inflicted policy decision to curb speculative activities and introduce caution in lending led to a debt crisis emanating from the Evergrande Group- China’s then largest builders. And given its US$ 300 billion in outstanding debt this caused knock-on effects: stalled projects due to lack of funding led to mortgage boycotts by disgruntled buyers which spread across over 80 cities by July. Sales of property collapsed 25% from last year, home sales by 60%. Needless to say, this is going to act as a drag on GDP growth until the market resumes earlier production levels but with vast inventory overhang, abysmal sales and the knock-on effects on the financial sector this is likely to need time to play out.
The last leg that seems to have collapsed in China is the climactic leg. In a world with climate disasters aplenty China has faced a massive drought that is drying up all its main river systems- reducing hydroelectric power production, damaging crop growth and creating water shortages in its cities. The record-breaking heatwave may be the final straw that breaks the economic giant’s back. Like in Europe, shipping has been badly affected with the Yangtse River unnavigable in stretches due to the low water levels. The water supply to Sichuan’s hydropower reservoirs fell by over a half- just when electricity demand shot up by 25% because of the intense heat. Companies were forced to shut down production and Toyota, Foxconn and Tesla were forced to suspend operations because of the combination of heat, lack of power and inability to transport goods along the riverways. Even peanut production- China is the world’s largest producer with 36% of global production, normally thought to be drought resistant, is expected to be down 30% this year.
All of this is hitting China at one go. 2022 is expected to see Chinese GDP grow by a mere 3.3% according to the IMF. This is bad news for global recovery and represents a down-marking of 1.1%. An optimistic projection for next year suggests growth could be 4.6%- still below par. China is one of the biggest engines of world growth. As the 2nd largest economy and the world’s factory any setbacks there will have repercussions down the line. The Chinese Yuan, until recently a haven from the inflationary shock hitting the rest of the world, has been tumbling now for 6 months. Just this fact will put pressure on all emerging market currencies as their currencies become uncompetitive against the Yuan. China is a significant trade partner to many Emerging Market nations. But any downward correction to compensate will push their overseas debt costs higher in local terms- an unpleasant dilemma to be caught on.
Fig. 1: China’s trade exposure with EM countries
Source: Bloomberg
Even with China attempting to slow the Yuan’s descent (much like India) this is likely to be felt amongst currencies like the Turkish Lire, the Hungarian Florint amongst others. But it is the fall in buying from these nations that will lower world growth further. The chart above shows the dependency of many nations on Chinese orders. The slowdown in China is the equivalent of one wheel of global growth falling off. Let’s hope others don’t follow.