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China's Economy is Facing Its Biggest Challenges in Decades

Published by Tavex Analysts in category Market News on 25.07.2023
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China, the world’s second-largest economy, is grappling with its most severe economic challenges in decades. From high debt levels in the real estate sector and local governments, low returns on investments, to low household confidence and geopolitical tensions, the country seems to be facing a perfect storm of problems. These issues, compounded by the impacts of the pandemic, are pushing China towards an economic downturn and potentially, deflation. In this in-depth exploration, we delve into the myriad factors straining China’s economy and the potential long-term consequences.

China’s economy is facing its biggest challenges in decades and is running out of tools to solve them, experts say. The country’s latest macroeconomic data suggest it is on the verge of deflation, writes The Epoch Times.

The consumer price index for June was virtually unchanged on a year-on-year basis, falling 0.2 percent from May. The Producer Price Index, which reflects wholesale prices, fell by 5.4 percent compared with June 2022. In May, the same indicator decreased by 4.6 percent.

June trade data also showed a continuation of the downward trend. The value of China’s exports fell by more than 12 per cent in dollar terms over the year, compared with a decline of 7.5 per cent in May. Imports fell nearly 7 percent compared to June 2022.

China is the world’s second largest economy after the US. The country has been hit by a series of economic woes, including high debt levels in the real estate sector and local governments, declining returns on investment, low household confidence and geopolitical tensions with the US and the European Union, says Gary Jefferson, an economics professor at Brandeis University who specialises in the Chinese economy.

Jefferson says this is a consequence of government policies over the past 30-40 years.

There has been much talk that China’s economy has been particularly troubled by the pandemic and tight coronet restrictions. However, Jefferson believes that structural problems can probably be mainly blamed.

“The nature of the problem is that economic and social confidence are simultaneously affecting each other,” Jefferson told The Epoch Times.

“There are fewer people getting married and having children, which is one of the reasons for the worsening economic situation. This, in turn, worsens the economic situation. When there are fewer families, the number of larger and more successful households falls. This weakens the property sector and the local government revenue base.”

In China, the birth rate is falling rapidly, despite the abandonment of the one-child policy in 2016, which now allows three children per family. However, many couples are reluctant to have more children, with high costs cited as one of the main reasons.

Biggest difficulties since 1989

“The government is now in its most difficult situation since 4 June 1989,” added Jefferson. On that date, the Tiananmen Square massacre took place, with students demanding democratic reforms and an end to international isolation. After that, it took China’s economy three years to get back on track.

Jefferson pointed out that although the economy was able to grow again in the early 1990s, the current situation is very different because the economy has developed a lot.

For several decades, Chinese people and businesses have been building up savings and investment opportunities have been abundant. However, Jefferson says there is no sign of a rapid recovery now because the authorities are running out of tools to stimulate the economy.

After the 2008 financial crisis, the Chinese government decided to invest 4 trillion yuan ($586 billion) in the economy through a massive aid package. This led to a sharp increase in spending on infrastructure and increased the borrowing burden on both the real estate sector and local governments.

Compared to 10 years ago, the return on capital investment is much lower. This is partly due to the large amount of money already invested in infrastructure and the significant increase in the number of people entering universities since the 1999 reforms. China’s youth unemployment rose to 20% in the spring, partly because there are too many university graduates. While 20 years ago, a million people a year were entering university, now it is 10 million.

According to Jefferson, stimulating the economy will require huge spending by the central and local governments, which will mean an even bigger debt burden. This is very problematic. If people have more money, they can put it in the bank or use it to pay off debts. So giving money to people may not stimulate consumption, he added.

The professor pointed out that China’s current situation could be compared to a car driving up a hill, facing a steep drop-off. “In the past, the steep slope has been shallow enough that the car has landed and kept going,” he said. “Now, however, we have a situation we haven’t seen in 40 years. The ravine is so deep that a safe landing is problematic.”

The main difference between Chinese and Western economies, Jefferson said, is that while the legitimacy of Western governments depends on elections and legislative processes, the legitimacy of the Chinese Communist Party depends almost entirely on the economy.

“This makes it very difficult for the party to accept and cope with the recession,” he added. “This is a difficult and embarrassing situation for the country’s leaders.”

“I no longer see hope”

Mike (name changed), 27, works in a factory in Zhejiang province, China. He graduated in 2017 as a metro engineer. In July 2020, his 2-year contract in Hunan province expired and he moved to his current residence to work in a factory that just opened. The factory specialises in high-quality products that are exported abroad.

In May last year, a large western company decided to stop ordering from the factory. The reason given was geopolitical tensions between China and Europe. Since then, the factory has been unable to find a replacement for a major customer. Production has now been stopped and the company is selling its stocks.

According to Mike, the company is looking for ways to focus more on the domestic market. However, this is difficult because demand is low.

He said other companies are also facing problems. A nearby auto parts manufacturer recently laid off 3,000 workers, or 30 percent of its workforce. The remaining workers are no longer allowed to work overtime, which helped boost their incomes.

When Mike moved to Zhejiang, he felt his life was moving in the right direction. He bought an apartment in the city in October 2020. But the economy was deteriorating and three years of coronavirus restrictions were wearing on many. “I don’t see any hope now,” Mike told the Epoch Times. “Everyone is under a lot of stress in life.”

As a factory supervisor, he earns about 9,000 yuan, or $1,260 a month. He pays 6,000 yuan a month for his apartment – two-thirds of his income. After all the necessary expenses, he has practically nothing to save and needs to buy a car. Many women in China expect their husbands to have a place to live and a car before they get married. His girlfriend doesn’t expect him to, but Mike sees this achievement as a “man’s duty” before marriage.

Mike hopes to save enough money to pay for his parents’ medical bills. He wants to have a baby, but is trying to get to a better place financially first. When asked if he wanted to have more than one child, Mike said without hesitation, “I couldn’t afford it.”

China’s state media writes that the country’s economy is recovering steadily. Mike thinks this is propaganda and that people are living in a completely different reality. “There is a recession in my life,” he added.

The relationship between the private sector and the government

China’s Communist Party leaders have recently been holding a lot of meetings with business leaders, especially those from technology companies. This shows that the state is keen to ease restrictions on the private sector over the next three years.

Chinese economic analyst Antonio Graceffo said there had long been ambivalence between the party and the private sector. “Of course if they are communists, they must hate the private sector. At the same time, China wants economic growth, and it is understood that it will come mostly from the private sector,” he told the Epoch Times. “They are smart enough to understand that. So they don’t want to give up the golden eggs coming from the private sector.”

Jefferson said the Chinese government has never abandoned the “birds in the cage” mentality. This is also the attitude of the current President Xi Jinping. Chen Yun, who played a major role in the “opening up” of the economy in the 1980s, said at the time that after reforms the private sector should act like a “bird in a cage.” The market economy would be constrained by the walls of the cage, reflecting the central management of the economy.

Mike says he doesn’t trust government meetings with business. The main problem, he says, is that they are not led by President Xi, whom he calls the emperor. If someone else is in charge, any decision made can be overruled by the president, and in Chinese society politics is more important than economics. The party’s priority, he says, is government spending and holding on to power. This means that, when the economy is stimulated, the money does not reach ordinary people and the elite benefit most.

According to Mike, more and more people are starting to think about the problems that are plaguing the Chinese economy. A year ago, people were blaming the US for the problems, reflecting the party’s propaganda. Now people are complaining more and more about the problems that are pervasive in Chinese society, for example, there is much more talk about corruption in the authorities.

What will happen in the future?

The Chinese Communist Party has not yet introduced any major stimulus measures. In June, the central bank lowered interest rates and property developers were granted credit extensions, which should ensure that home building continues.

In April, the world’s most indebted developer, Evergrande, reached a loan restructuring agreement with creditors. This will give creditors access to the company’s Hong Kong-based assets.

At the beginning of July, Chinese Premier Li Qiang announced that measures to address the problems in the economy would soon be made public.

The government is expected to come out with a stimulus package aimed at completing pending construction projects, Graceffo said. However, he added, this will not boost demand and will only give a temporary boost to employment. Some of these wages may be channelled into consumption, but apartments and commercial houses will remain empty in the long term.

Graceffo said that in the short term the Chinese economy will get worse. In the longer term, China may no longer see growth of 5%. People were used to higher growth in previous decades. China’s target for this year is 5% growth.

“I don’t see growth picking up again in the long term,” Graceffo said.

As China’s economy grapples with unprecedented challenges, the future seems uncertain. A lack of immediate solutions and a paucity of economic stimulation tools are exacerbating the situation. While measures like lowered interest rates and credit extensions to property developers are on the table, their efficacy remains to be seen. The key to long-term economic sustainability could lie in how effectively the government navigates these critical issues, balances the private sector’s role, and potentially accepts and adapts to a period of slower economic growth.

 

Gold price (XAU-GBP)
1,834.81 GBP/oz
  
- GBP3.58
Silver price (XAG-GBP)
24.70 GBP/oz
  
+ GBP0.52

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