Paul Diggle
Hello and welcome to Macro Bytes, the economics and politics podcast from abrdn. My name is Paul Diggle
Luke Bartholomew
And I'm Luke Bartholomew.
Paul Diggle
And today we are talking about the Chinese economy, where there has been a blitz of recent monetary and fiscal policy announcements which have seen the previously beaten- up Chinese equity market experience something of a sharp rally. But against a backdrop of structural economic headwinds and potentially damaging fallout from the US election, investors are wondering whether Chinese policymakers will actually follow through with the sort and size of stimulus that might turn the economy around.
So we are joined by Robert Gilhooly, the China economy expert here at abrdn, to talk through all of this. Welcome back to the pod, Bob.
Robert Gilhooly
Hi, Paul.
Paul Diggle
So let's start then. Bob, by you giving us a sense of the challenges that the Chinese economy has been facing. What are the headwinds that have weighed on growth and sentiment recently?
Robert Gilhooly
Yeah, I mean, there's a kind of laundry list of growth concerns around China. I’d probably still say that a good chunk of the more recent challenges, if we are looking at a slightly shorter time horizon, is the kind of still battling the fallout from policies put in place during the pandemic, in particular the decision to de-risk the property sector. But then also to, I guess hold the zero-Covid policy for an extended period of time without really providing any fiscal transfers to households either.
So, you know, real estate's been a pretty well-known vulnerability for a long time. A large share of economic activity, deep roots into the financial sector, and also a key source of revenue for local government, so you know all of which could amplify the drag from any housing crisis. The authorities are clearly becoming increasingly concerned about excess building combined with a well-known shrinking population going forward. You know, they decided to take action on that. I do think a good chunk of this adjustment and cost to de-risk the sector probably has already taken place, but it's still not fully worked its way through new starts - so new builds effectively are down around about 70% as the authorities try to get a grip on excess capacity. Building volumes and also value sales down around about a half. They’re certainly not falling at the same pace they were so the hit to GDP is probably mostly done, but the adjustment is definitely not 100% complete either. And then we've got this bigger secondary impact by consumption too. So house prices have taken a big hit in China. The official national numbers for existing residential is down about 13%. But many cities will have seen much bigger falls. And that's a pretty big hit to household wealth. Chinese households have got much of their money tied up in property, not very much in the stock market. It's all very much, you know, domestically held. They don’t tend to hold very many foreign assets either. So, you know, given this big hit to household wealth plus a kind of lackluster labour market that's being kind of squeezed by kind of structural changes on that side too, is perhaps not a surprise that consumer confidence remains, pretty much near kind of record lows and how because of that they've just not been rushing to spend that money that accumulated over the pandemic either.
Paul Diggle
Threre’s been a lot of talk about the 5% GDP growth target for this year potentially being missed. I suppose, given doubts about the reliability of the Chinese GDP figures, it might be best to look for this weakness showing up in the sort of data you've been highlighting - consumer confidence and housing market activity. And what's going on with inflation? What's going on with youth unemployment, which I think people have long talked about as being a particular problem in China?
Robert Gilhooly
Yeah. You're right. Look, it's always a difficult one to track – the Chinese economy - not just because of the concerns about GDP, but, you know, the array of indicators that we have is often more skewed towards, manufacturing and investment. We actually have relatively few good high-quality indicators on the labour market in particular. Indeed, the authorities actually stopped producing youth unemployment numbers for a good six months or so while they put through methodological improvements, which just happened to lower the youth unemployment rate back down. But what we can see from kind of survey evidence is that concerns about employment and income outlook remain very, very high. Even the official numbers on youth unemployment, you know, they still look a little bit on the high side. And then, you know, inflation numbers, they've just kind of continued to remain pretty tepid. So we’ve had a long period of headline CPI inflation being at negative - in deflationary territory. That headline has at least been positive for the last eight months or so but we've seen core inflation, most recent data, slow down to a mere 0.1% year-over-year. So I think that's kind of illustrative of the problems of excess capacity, relatively weak consumption still in the economy, kind of showing up in this weak nominal backdrop. And indeed, when we get the GDP data that’s coming out this Friday it’s probably going to show the GDP deflator extending a near record run of falling whole economy prices.
Luke Bartholomew
And so outside of some of those cyclical considerations you're outlining there Bob, the weakness of nominal growth, for example, and what sounds like a balance sheet recession, I also wonder, is there a sense that kind of what's happening in China is that the long run is catching up with the economy, if you will? You know, is the limits of its investment driven growth model being hit around the same time that the demographic headwinds are also starting to bite as well? So along with these cyclical considerations, there are deep structural headwinds as well?
Robert Gilhooly
Yeah, I think so. These have kind of always been rumbling along a little bit in the background. We did of course find out that the Chinese population began to fall maybe a little bit earlier than people were expecting – and that that started to contract in roughly 2022. So, yeah, that demographic challenge is coming a little bit earlier than maybe we’d thought, and then I guess, you know, China has been running a form of investment-led, export-led development model for quite a long time. Potentially now we're getting to the point where China's sheer size means that this kind of export-led model is harder to sustain. And, you know, you might think of that as that's one reason why we're kind of seeing tensions flare on trade with both the US, but also more recently with the euro area and China's sudden emergence as an electric vehicle manufacturer. I guess there's probably a couple of kind of counter arguments though on this. Particularly for kind of thinking about the risks of, you know, could China stumble into the ‘lost decades’ as Japan did in the 1990s? And first of all, would just be the stage of development. You know, Japan was an advanced economy when it ran into trouble with the end of the 80s, early 90s. China is sort of only running around about a quarter of US GDP per capita. China still has a reasonable number of people working in agriculture and that kind of sectoral reallocation from low productivity, low wage, agriculture jobs into higher productivity manufacturing services jobs can still be an engine of growth. It’s also the case that demographics for China look a bit less acute when we look at trends in the workforce rather than total population. There's also still quite a bit of scope to kind of boost human capital and skills through education and training in China and, you know, more generally just for kind of businesses probably to kind of move more to the frontier, if you will. And indeed, you know, I guess the sudden emergence of China as an EV manufacturer is probably illustrative of China's ability to kind of catch up and push the boundaries as much as it is about China's growth model amplifying these geopolitical tensions.
Paul Diggle
But notwithstanding those reasons why China probably isn't heading for much of that Japanification, the disappointing growth backdrop that you've outlined there, Bob, has certainly been a reason that China has been out of favour among international investors. And, you know, it hasn't just been the growth picture. It's been, as you said, tensions with the US, with the eurozone, concerns in the medium to long run over Taiwan and the South China Sea, China's geopolitical relationship with Russia, its low yield versus other EMs. And I want to also ask you in particular about this sense in which Chinese equity markets themselves may not have been able to capture fully China's economic rise. Why would that be? And why would say other markets in the US or Europe have been better able to capture China's economic rise in share prices?
Robert Gilhooly
Yeah, it's been a really interesting kind of feature, I think, of the China growth to equity performance cross-over there. China's, you know, still an amazing growth success story and one we think at least will last for quite a long time. But you just don't really see that in equities, even with the sudden rebound in equities we've had recently. Equities are only back kind of around about their 2019 levels give or take. If you've been holding Chinese equities for a very long period of time, depending on exactly when you bought, you may be kind of sitting on either a loss or potentially have not really seen any gain in your equity prices. Now, I think there's some of this is actually western manufacturing companies were able to come into China, set up operations. To some extent they were the ones kind of tapping into some of that Chinese growth story - perhaps in a way that some of the domestic players weren't actually able to. Part of the Chinese growth model has also been one of let's make a hyper competitive economic landscape. This will, for a while anyway, result in a fairly kind of low profit corporate backdrop, but eventually those firms that survive will be world class, potentially even world leaders. So, I think there is an element of by design that's not particularly favorable to equities performance.
Luke Bartholomew
So Bob, we typically think of macro policy as having the potential to boost cyclical growth, close output gaps, and even at least partially to deal with some of China's long-term structural problems. But, you know, the story until at least very recently, is that policy hasn't been doing this, that it has been this very piecemeal, incremental approach focused on monetary policy, which perhaps doesn't really gain traction in the kind of balance sheet or liquidity trap problems that China faces. And maybe it's been so supply-side focused, which just ends up exacerbating the deflationary pressures. So why for so long did policymakers follow this rather piecemeal approach?
Robert Gilhooly
Yeah, I think it's partly a story of policy pivoting towards resilience and other policy priorities, such as kind of national security. So I thought it was quite telling in China's Third Plenum recently, you know, security was very much noted as being the foundation for China's modernisation drive. Relatedly, resilience has been repeatedly emphasised in several key Chinese policy meetings over the last say five years or so. So, you know, even if this policy might involve a degree of capital misallocation, a degree of kind of deflationary or lowflationary pressure being embedded in the system, it seemed to be that the authorities were effectively willing to take this trade off. So, you know, that trade off would allow you to become more self-sufficient, more resilient, less perhaps at the whims of external actors, such as maybe the US in terms of kind of geopolitical pressures and geo political damage. But I think, while this kind of security and resilience angle has been important, that we should also think about this as a re-appreciation of the quality, not just the quantity, of growth. So, for example, if we tackle the housing market risk, you know, potentially removing a very substantial negative tail risk that could morph into a kind of economic and financial crisis. Or maybe, perhaps by deflating the property bubble now rather than let it burst in a more spectacular manner at a later date, you know, you're actually kind of protecting future growth, albeit maybe at the expense of current growth, as well.
Luke Bartholomew
And I'm also wondering, do you think there's any ideological content to these policy choices as well, in the sense that people sometimes talk about the authorities having this anti consumption or anti welfare streak? They're concerned about the kind of incentives or the structure of economy that creates. And then perhaps relatedly, the sense that perhaps the Chinese equity market is a less important barometer of success in China than it might be in other countries? So is there an ideological sort of underpinning to some of these choices as well?
Robert Gilhooly
So while we've seen the Chinese authorities step in most recently to kind of support the stock market, it probably is true to say, from a kind of slightly more ideological perspective, that it’s less clear that it is such a key barometer of national success. These are maybe kind of elements where the Chinese authorities are a little bit wary of letting the stock market run too hot for too long. Indeed, I think the general experience back in 2014/15, when the stock market rapidly rose and then spectacularly burst again is maybe one reason why they are less, or have been less, gung ho about equity performance. So, you know, an aversion to volatility seems to be part of maybe the Communist Party ideology.
Luke Bartholomew
And so bringing the story up to date then, and we've alluded to this several times now that there has been, over the past couple of weeks a series of big policy announcements, do you want to talk us through a little bit about what has changed, what has been announced recently? And I suppose, the big question sitting on top of all of those announcements is that, you know, there's little doubt that what has occurred is probably not enough to solve all of China's cyclical and structural problems. It's not, you know, to use a phrase, that’s often used in markets, the ‘big bazooka’. But I guess the 1 trillion RMB question, if you will, is whether this is a step change in approach that should leave investors more confident on the outlook? So is there enough in what's been announced to feel that there has been a change in the organising principle behind stimulus and Chinese policy actions?
Robert Gilhooly
I think we're potentially getting there on that approach. Look, I mean, there are probably three key changes that I would say definitely offer kind of hope that the Chinese policy has pivoted into a better place.
First of all, you know, the PBoC had been quite concerned about low rates and had been kind of reluctant to actually cut rates. These more aggressive moves we've had recently seemed to open the door for further moves. This kind of removal of concern about financial stability risk, that had actually been leading them to buy long-dated, government bonds, at least, you know, that seems to have gone.
Secondly, you know, one reason why policy seemed very incremental and quite piecemeal for a long time was that the top of the Communist Party was concerned about kind of ‘wellfarism’ and didn't want to get kind of households used to being bailed out via fiscal transfers. But now it seems like there's a greater recognition of the importance of supporting households with fiscal.
And thirdly, I think just the tone and the rhetoric around stabilising the property market, I think that's definitely gained a much bigger sense of urgency. So all that is potentially quite supportive for markets.
Paul Diggle
There has, however, been a real lack of details in the announcements so far at least. And I think various stages of disappointment in international markets about the size of measures. So do we have a kind of an idea Bob of the scale and indeed specific measures that are probably required from here to keep the recent improvement in international sentiment towards China going? I mean, what do they need to do? How big do they need to go to actually make a difference to the various headwinds that we started the podcast by talking about?
Robert Gilhooly
Yeah, look, I think there's still a lot we don't know. And I think it's going to be not just like a question of okay what's the size of the package? And here we're really thinking about both fiscal and monetary, but probably more so on the fiscal side. It’s really more about the composition and what are all these policy levers doing in conjunction to drive growth? So, I mean, what are the kind of rumors or the market consensus at the moment? We have this Reuters report which seems fairly credible, that maybe there will be a 2 trillion renminbi fiscal package. Now around 1 trillion of that is earmarked for dealing with debt problems at the local level. Some of that could be kind of stopping fiscal austerity. So that could still be useful. And then 1 trillion is kind of more consumption measures potentially aimed at households and businesses to upgrade appliances and upgrade equipment. And then we believe there will also be a bank recapitalisation which will probably be worth around about a trillion. And then the latest news, which is kind of related I think to this Reuters report that could potentially signal a bigger support package is that maybe we actually get something much more substantial on local government debt. So swapping out higher interest paying local government financing vehicle debt, swapping out with ultra-long centrally-issued debt, and potentially you know, you could be talking of a number around about 6 trillion. Now, all that sounds like a lot of very big numbers. But we've got to think about kind of what the real stimulus I think, of that is. So, you know, debt swaps are great, frees up a little bit of fiscal space at local level, but not as much as that sort of big number would imply, Similarly, it's not really obvious that you should think of bank recapitalisation as being stimulus. On the margin maybe it helps support its lending. But it's not super clear that's definitely the case. So I think the thing people are really looking out for at the moment is kind of what is actually going to be the size of what I would call ‘genuine’ quote unquote ‘genuine’ fiscal stimulus aimed at households, aimed at corporates, or how are we going to see that kind of credit impulse come back through? So, you know, if we were adding up some of that stimulus, you might only be talking about sort of 1.5 trillion, abstracting away from the kind of bank recap and local government debt swap. Just to give you a bit of context, you know, okay, 1.5 trillion, maybe it's more maybe it's 3 trillion. That sounds like a big number. You know back in 2008 with a 4 trillion stimulus that was widely credited as giving the global economy a huge shot in the arm. But back in 2008, you know, 4 trillion was 12.5% of Chinese GDP. 4 trillion now is only around about 3% of Chinese GDP. So I think we really need to see some fairly big chunky numbers come through on fiscal stimulus coming through for households and corporates and we certainly aren't there yet. So there is some risk, I think, of market disappointment as we go through.
Paul Diggle
Great. Well, that's about all we have time for this week. Thanks very much, Bob, for joining us. Thank you for listening to Macro Bytes. Don't forget to like and subscribe to the podcast on your platform of choice. But, until next time, goodbye and good luck out there.
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