Harun Thilak, Senior Associate
In the realm of global economic powerhouses, China has emerged as a true force to be reckoned with. Over the past few years, this Asian giant has not only propelled its own growth but has also become an integral part of the global economy. Ranked as the world's second-largest economy, surpassed only by the United States, China boasts the impressive title of the largest exporter of goods and the largest importer of industrial commodities. Its influence extends far beyond trade, as it takes the lead in global infrastructure investment through its ambitious Belt and Road initiative and contributes significantly to global consumer demand, thanks to its staggering population of 1.4 billion people and the rapid rise of its middle class.
Significant challenges lie ahead for the Chinese economy - to bolster domestic demand and activity levels, China had embarked on an aggressive monetary policy easing in 2022 (while most of the Western world were hiking rates to rein in excessive domestic inflation) and continued monetary and fiscal easing may be necessary to prop up the sluggish economy. Failure to regulate the real estate sector sufficiently while it was booming has left regulators in an impossible position - stepping in to pay people’s mortgages or bailing out the developers will lead to a serious moral hazard problem while doing nothing could have serious repercussions on the economy (property sector contributes to about 20% of China’s GDP). To help restore confidence in the critical real estate market China will continue credit financing for developers, to help get stalled projects back on track, whilst working on long-term structural reforms concerning how the developers work with local government, state-owned banks, and their customers.
However, China charted a different course than the Western world in its response to the Covid-19 pandemic. While the rest of the world grappled with various strategies, China implemented a Covid-zero policy marked by stringent mobility and border controls, along with aggressive quarantine measures. This approach, albeit prolonged compared to Western counterparts, eventually paid off, as restrictions were gradually eased in November 2022. In a momentous declaration, President Xi Jinping announced China's victory over Covid in February 2023.
As the easing of Covid restrictions gained momentum in late 2022, market anticipation for the full reopening of the Chinese economy reached a fever pitch. It became one of the most widely discussed themes for 2023. Speculative demand surged for industrial metals such as iron ore and copper, driving significant price increases of around 15-17% from November 2022 into early 2023. Commodity-linked currencies, including the Australian and New Zealand dollars, also gained strength against the US dollar, which was further weakened by potential dovish policy shifts by the Federal Reserve.
Nonetheless, a reality check soon dampened the initial exuberance that characterized early 2023. Multiple indicators of economic strength, such as industrial production, import/export volumes, retail sales, and the Purchasing Managers' Index (PMI), revealed troubling downward trends. Moreover, GDP data failed to live up to the lofty expectations set by earlier optimism. Several factors contributed to this weakness, including reduced purchasing power among Chinese households recovering from the pandemic, a protracted slump in the property sector fueled by a credit crunch among developers, and sluggish global demand stemming from Western countries potentially facing recession due to monetary tightening. Consequently, industrial metals and commodity-linked currencies surrendered their gains from earlier in the year, as market interest in the China reopening trade waned.
The Chinese economy now faces significant challenges on its road to recovery. To stimulate domestic demand and economic activity, China pursued an aggressive monetary policy easing in 2022, diverging from the rate-hiking measures implemented by most Western nations to counter excessive domestic inflation. Continued monetary and fiscal easing may be necessary to prop up the sluggish economy. The real estate sector, in particular, presents a daunting regulatory quandary. Neglecting to address the sector adequately during its boom has left regulators in a precarious position. Intervening to cover people's mortgages or bailing out developers would create a serious moral hazard, while inaction could have severe repercussions on the overall economy. Given the sector's significant contribution of approximately 20% to China's GDP, the government aims to restore confidence by providing credit financing to developers and reviving stalled projects. Simultaneously, long-term structural reforms are underway, focusing on improving relationships between developers, local government entities, state-owned banks, and customers.
Perhaps the market's expectations of China swiftly returning to full economic throttle were premature, and the challenges that lie ahead are undeniably substantial. However, the country's current political structure positions it well to devise expedient solutions to these issues, even if they come at a cost. Regardless of the outcome, China's position in the global economy remains unshakable. As the world watches with bated breath, China maneuvers its way through the post-Covid slump, determined to assert its influence on the global stage.
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