Workers hang off the side of the construction site of a block of flats in Beijing on July 29. Turmoil in the housing market is one of several factors raising concerns about the state of China’s economy. Photo: Reuters
Opinion
Aidan Yao
Aidan Yao
China economy: Beijing must follow words with action to restore growth and confidence
The raft of second-quarter economic data should lay to rest lingering doubts about China’s post-pandemic recovery having run its course
Beijing’s macroeconomic policies are out of sync with reality, and policymakers must take action to avoid missing an already-conservative growth target
Recent data for the second quarter provides comprehensive evidence that China’s post-pandemic economic recovery has run its course. Nearly all data points missed market expectations despite year-on-year growth accelerating from the low base induced by nationwide lockdowns.
If there were any remaining doubts, the numbers have put a nail in the coffin on the debate over the state of China’s economy and whether Beijing needs to take action to halt the slide.
A few aspects stood out as particularly worrying. First is the speed at which the economy is slowing. This would seem odd to those who focus only on year-on-year GDP growth, which accelerated to 6.3 per cent from 4.5 per cent in the first quarter.
However, removing the flattering base effects, sequential growth shrank by more than half to only 0.8 per cent on a quarterly basis. This is clearly more consistent with high-frequency data pointing to faltering growth momentum in the past few months.
Another way to demonstrate this is by looking at the two-year-average-compound growth rates, which present annual GDP growth without base effect distortions. On that measure, growth slowed to 3.3 per cent in the second quarter, from 4.6 per cent in the first.
02:31
China’s youth unemployment rate hits new high as recovery falters
China’s youth unemployment rate hits new high as recovery falters
This shows not only that the economy is operating below its potential, but – perhaps more importantly – it is also below Beijing’s full-year growth target. To achieve the government’s goal of “around 5 per cent”, growth needs to accelerate to above 4 per cent on a two-year-average basis in the second half of the year, which is no easy feat without significant help from Beijing.
Another troubling sign is that deflation has become more widespread. Optimists might reject this by pointing to the flat consumer price index (CPI) as showing things are not that bad. However, the GDP deflator – a more comprehensive measure of price dynamics – fell 0.6 per cent in the second quarter, dipping into negative territory for the first time since 2020.
Note that not even acute deflation fears during the deleveraging and destocking that started in 2015 were able to pull this measure below the waterline. This provides a historical context for thinking about the scale of the pricing challenges and the need for monetary policy action.
Finally, the data was crystal-clear on the cause of the current economic malaise: a severe deficiency in demand is to blame, while supply is still humming along. In fact, better-than-expected industrial production growth was the only bright spot in the June data.
However, this surprising re-acceleration of output is precisely why deflation has taken hold. The picture on the demand side is decidedly weak. Foreign purchases of Chinese products are slowing, with little indication of a turnaround any time soon.
Domestically, poor confidence and tight government policies have held back business investment and employment, which in turn undermined household consumption. Notably, retail sales growth collapsed to 3.1 per cent from 12.7 per cent in May as the percentage of unemployed young people climbed to a new high of 21.3 per cent.
More worryingly, service-sector activity, which held up at the beginning of the quarter, also lost steam, suggesting pent-up demand has started to wane. Last but not least, the property market is in crisis again, with home sales, starts and investment growth all contracting sharply.
Overall, the data points to the Chinese economy being in a precarious state, highlighting the need for Beijing to take decisive action to, at the very least, prevent its countercyclical policies from becoming pro-cyclical.
A homebuyer walks through a construction area on June 2, in the compound where he bought a flat in Ningbo, Zhejiang province. Developers have struggled to raise funds to complete homes they sold in advance. Photo: AFP
This is true for monetary policy. Despite attempts to loosen it by cutting interest rates and injecting liquidity, monetary conditions have actually tightened in real terms because prices have fallen faster than nominal funding costs.
Take bank loans as an example. The average lending rates have declined by 25 and 107 basis points for corporate and individual borrowers respectively in the first half of the year relative to 2022. But this was more than offset by the falls in the CPI and producer price index, leaving real interest rates notably higher.
In fact, with factory-gate prices in deflation, many small industrial firms are now paying double-digit interest rates to stay afloat. Failing to keep up with price changes, therefore, means the People’s Bank of China has fallen far behind the curve under its “prudent” policy settings.
Conditions are no better on the fiscal side. The latest data shows that fiscal revenue in the official budget account grew by more than 13 per cent in the first half of the year, much stronger than GDP growth. Meanwhile, spending increased by less than 4 per cent, weaker than GDP growth.
What’s more is that fiscal spending in the government fund account – which is supported mostly by land sales – collapsed by 21 per cent as property-related revenue dried up.
This has led to a 32 per cent fall in the augmented fiscal deficit – the broadest measure of the fiscal gap – relative to 2022, despite the government’s pledge of an “active” fiscal policy.
All this provides damning evidence that China’s macroeconomic policies are out of sync with economic reality. Fortunately, it has not gone unnoticed by policymakers – the latest Politburo meeting pledged a host of measures to steer the economy back towards recovery.
However, words are cheap without action. Beijing needs to put its money where its mouth is to avoid failing to achieve what was seen as a conservative growth target just a few months ago.
Aidan Yao is a macroeconomist with more than 15 years of experience in both public- and private-sector organisations
