Photo: TheStar
Written by Alicia Garcia-Herrero
The sudden and immediate reopening of the Chinese economy after three years of zero-Covid policies on December 8 last year was accompanied by a rapid positive turn in foreign investors’ sentiment, leading to a surge in portfolio flows, especially equities. This shift was based on the experience of other economies’ pent-up post-pandemic demand. Yet China seems to be following a different pattern.
While China’s services demand has been resilient, the sales of consumer durables have been disappointing, largely dragged down by cars and property-related consumption. Fixed-asset investment is an important contributor to growth, but it grew only 4 per cent in May 2023, which is lower than the 2022 average. This is not only true of shrinking real estate investment because manufacturing investment is also growing more slowly than last year, when China had a countrywide lockdown.
China’s contracting purchasing managers’ index data for May also confirms the negative sentiment on manufacturing, which should not be surprising given that industrial profits have plummeted in 2023, with close to 20 per cent negative growth in April.
Although the poor performance of the manufacturing sector and its divergence versus services is a global problem, China’s case is particularly important because it is the world’s largest exporter. Its global manufacturing export share is more than 20 per cent.
What has become increasingly apparent is that, flagging external demand is further weighing on China’s manufacturing as well as exports. In fact, China’s exports have already turned to negative growth in May, plummeting by 7.5 per cent. This has resulted decline in its trade surplus from close to 100 billion at the beginning of the year to only 66 billion in May. The reopening of China’s economy was widely expected to unleash the excess savings that had accumulated in bank accounts during the pandemic. This has not transpired.
Against such a backdrop, what was considered an underwhelming growth target of 5 per cent for 2023 when announced at the Communist party’s main gathering in March, is now perceived as increasingly challenging.
The People’s Bank of China has been pushing banks to lower their deposit rates in order to entice consumers to spend. It finally came in June, when China’s six largest state-owned commercial banks lowered their interest rates for deposits, paving the way for a new round of monetary easing. Subsequently, the PBOC cut 10 basis points in its benchmark lending rates including the 7-day reverse repo rate and medium-term lending facility (MLF) rate. The decline in policy rates has guided the 1-year and 5-year loan prime rates (LPR) to come down by 10 basis points each, though the market has expected a bigger reduction in the 5-year LPR.
Given the underwhelming economic activity, more policy support is expected to come in the next few months. But there’s reason to remain wary amid the central bank’s easing stance, as the China’s public debt has been increasing rapidly, hitting 97 per cent of its gross domestic product — and still excludes state-owned enterprises’ debt because of data constraints.
This year, the widened US-China yield differentials and worsening growth prospects, coupled with a depreciating yuan, are putting investors off a market that was expected to be this year’s darling. In fact, net portfolio flows continue to be highly negative in May, especially for bonds, according to the Institute of International Finance.
This contrasts with the idea that the easing of regulatory constraints on property and large tech companies would push the stock market up after the harsh government crackdown on both sectors since 2020. Instead, the stock markets of China and Hong Kong are flunking, as a result of negative market sentiment.
Down the road, the question is whether the stimulus package from China will be enough to shore up the economy and reignite foreign investors’ interest in Chinese capital markets, especially at this junction where the Fed returned with the pause decision but together with possibly further hikes. Beyond cyclical reasons, a whole new set of risks are emerging from America’s push for technological containment and the threat of western sanctions on China, either because of its support for Russia or what might unfold in Taiwan. In addition, China’s newly amended law against foreign espionage exemplifies its increasing wariness when it comes to foreign investors.
China’s hesitant recovery, its reduction in interest rates and its poor corporate profits are all deterring foreign investors. The gloomy outlook in terms of portfolio inflows is surely another important reason for it to guard its large trade surplus, even while the US and European economies head towards recession. This also means China will continue to push exports while exerting restraint on imports to protect its foreign reserves from what are, by now, pretty unavoidable portfolio outflows.
The author Alicia Garcia-Herrero serves as Senior Research Fellow at Bruegel and as Adjunct Professor at Hong Kong University of Science and Technology.
Global News Insider 