- China’s current corona policy is contributing to supply chain problems.
- Consumption growth in China is proving to be weaker than expected. This may be due to the economic effects of the Corona on low wage earners and the changed political attitude to the debt brake.
- Given the close link between the rise in debt and economic growth in China, crackdown on Chinese economy’s debt is likely to have both national and global implications.
The actions taken by the government to address the three big problem areas – corona, consumption and credit – explain China’s current situation and are likely to determine the country’s near-term course. In the longer term, China is trying to drive its economy forward through innovation and to manage the balancing act between profit and the protection of the well-being of its people. The scale and challenge of developing such a large economy is enormous. No other country has the ability or the ambition to do what China is doing. However, these efforts can have unintended consequences. Indeed, the simultaneous political shocks in various sectors have likely accelerated an otherwise natural economic slowdown, worsened consumer sentiment and contributed to recent market instability.
Corona
China is pursuing a zero tolerance strategy towards Corona. Whole metropolitan areas were cordoned off after cases occurred. It has been stated that a vaccination rate of 80-85%1 must be achieved before this strategy would be reconsidered. The manufacturing industry was not spared from this practice either, and strict requirements were imposed on the Guangdong Industrial Center. Such an approach, which can immediately stall economic activity and then turn it back on like a light switch, as soon as the number of cases declines, is disruptive. Because it is often easier to stop economic activity than to get it going again. Rising freight costs around the world are an indication of the congestion caused by China’s corona intolerance, which includes the closure of Ningbo-Zhoushan, the world’s third largest port, due to a positive case.
Figure 1: China’s vaccination rate exceeds that of the UK and US, but does not meet the 80-85% requirement for reopening
Source: Bloomberg, NCOVCNPV Index (China), NCOVGBPV Index (UK), NCOVUSPV Index (US), NCOVFRPV Index (France), August 8, 2021 to October 27, 2021
Figure 2: Rising freight costs for containers
Quelle: Bloomberg, WCI (World Container Index) Composite Container Freight Benchmark Rate (WCIDCOMP), 21. Oktober 2020 bis 21. Oktober 2021
consumption
Chinese retail consumption remains weak. It fell far short of expectations that it would improve once the restrictions were lifted. There are little signs of recovery, and post-corona retail sales growth in China remains well below the 8% growth rate2 before the pandemic recorded in December 2019.
The weak consumption could be due to the fact that the greatest burden of the economic impact of Corona is borne by those who are most vulnerable to it. Low wage earners make up 40%2 of the population, and labor market data suggests that their incomes have not increased at the same rate as those of the more profitable jobs like technology and financial services.
Figure 3: The income differences have worsened as low-income groups of the population had to bear the brunt of Corona
Source: Barclays Research, Special Topic: China, Political Development, September 2021
At the same time, household savings rates rose as a result of the lockdowns. However, they were not used by savers to bring about a consumption-oriented upswing when the economy picked up again. This could reflect the disruption and uncertainty inherent in the zero coronavirus approach, where sudden restrictions make it difficult to plan leisure spending. It could also suggest that consumers are cautious about their future employment prospects.
Figure 4: Rapid growth in savings
Source: Barclays Research, Special Topic: China, Political Development, September 2021
Credit
Another factor that could affect consumers’ willingness to buy is government crackdown on real estate. The government has stated that it does not want the housing market to become a speculative market. Real estate is of social importance in China and accounts for 23.3% of GDP3. The measures to stabilize the housing market are beginning to take effect. However, they seem to have overshot the mark and to slow down this growth engine.
Figure 5: Annual growth in apartment sales and their breakdown by district
Source: Nomura Global Research, China: Property-related indicators largely deteriorated in September, October 2021. The rank of a city is calculated from the average of its political position, its population and its GDP. Level 1 reflects the largest cities.
Part of the risk of a slowdown in the real estate sector coupled with tougher government debt policies has already shown itself in the troubles of Evergrande, the major Chinese real estate developer. The systemic risk posed by the Evergrande saga is likely to be low, as banks have limited direct exposure to real estate-related loans and China is likely to limit the effects of excessive exposure. Still, support is likely to be aimed at homebuyers rather than bailing out the businesses themselves, and the equity and credit markets may have to absorb some losses. The reaction can be observed in the credit markets: The credit spreads in China are widening. So far, the spread and expansion beyond China has been limited, as the spreads for high-yield and investment-grade bonds in emerging markets have barely changed.
Figure 6: Low response from credit markets outside of China
Quelle: Bloomberg, JPMorgan CEMBI = JPMorgan Corporate Emerging Market Bond Index, JBCDCBZW Index (Broad Diversified); JBCDIGZW Index (High Grade oder Investment Grade); JBCDHYZW Index (High Yield); JBCDCNZW Index (China). 1. Oktober 2020 bis 21. Oktober 2021
Efforts to control high debt levels in the real estate sector are part of general measures to limit credit growth. Important policy measures have been taken in support of the credit crunch strategy, including2:
- The People’s Bank of China (PBoC) restricts real estate lending (including trust and bond financing for developers and mortgages for consumers).
- The Ministry of Finance (MoF) tightened the requirements for local state finance companies (LGFV) and the issuance of bonds. The State Council also tolerated the failure of LGFVs.
- The Chinese regulator for banking and insurance (CBIRC) is tightening the handling of fiduciary and shadow finance and is aiming for a reduction of CNY 1 trillion in 2021.
China has seen significant debt-financed growth for decades. The increasing debt as a percentage of gross domestic product (GDP) is in a positive relationship to China’s per capita GDP. The risk to the world is that China’s deliberation to deleverage will result in slower domestic growth, which in turn affects global growth.
Figure 7: China’s debt-financed growth
Source: Bloomberg, CHBGDTOP Index (R1), GDCCPCHN Index (L1), December 31, 2004 to December 31, 2020
1 Source: Deutsche Bank, Exit Strategy Policy Tracker, October 2021
2 Source: Barclays Research, Special Topic: China, Political Development, September 2021
3 Source: Goldman Sachs Economics Research, China Data Insights: How Big is China’s Real Estate Sector, October 2021
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