Ever since China re-emerged last December from three years of COVID-19 restrictions that disrupted manufacturing and limited domestic consumption in the world’s second-largest economy, Wall Street has been optimistic about its recovery with the hope that it could help limit any global recession as central banks raised interest rates to combat inflation.
Now, seven months later, China’s economic rebound has disappointed investors.
The iShares MSCI China ETF
MCHI,
the largest U.S.-listed exchange-traded fund tracking Chinese stocks, has tumbled 7% so far this year, while the Invesco Golden Dragon China ETF
PGJ,
which tracks the Nasdaq Golden Dragon China Index
HXCK,
has declined by 4% over the same period, according to FactSet data.
In the Chinese market, the China CSI 300 index
000300,
which tracks 300 stocks with the largest market capitalization and liquidity from the entire universe of listed A-shares, was off 1.6% year to date, and Hong Kong’s Hang Seng index has fallen by 5%, according to FactSet data.
“This entire view of China’s boom post reopening was wrong,” said Gerwin Bell, lead economist for Asia at PGIM Fixed Income. “We need to take issue with the idea that the consumers are similarly able to be asked to drive the recovery — we never believed it.”
Consumer spending in China initially drove the recovery in the first quarter of 2023, but will not be strong enough to lift GDP growth to the 5% or 6% level, Bell told MarketWatch in a phone interview. PGIM’s data show that the rebound in real retail sales activity is already stalling and still far below the pre-2020 trend, which is the exact opposite of the U.S. recovery.
China set a modest target for economic growth this year of around 5%, the lowest target in a quarter-century, after growing by just 3% last year, one of its worst showings in decades.
See: Obstacles remain on China’s path from ‘zero COVID’ standstill to breakneck-pace consumption
Meanwhile, some Wall Street analysts also “fundamentally misunderstood” the nature of Chinese COVID-19 restrictions in which the Chinese government still kept the factories open and most business activities running, so what really resulted in a big slowdown in growth last year was not the lockdowns on the movement of people but the property sector, Bell said.
“Zero-COVID made investors believe that the biggest problems with China are COVID policy and completely distracted them from the chronic illness,” said Marko Papic, chief strategist at the Clocktower Group. “The zero-COVID policy was like an acute shock, but the chronic illness of China is that households are over-leveraged. That’s the source of the problem in demand.”
See: China ETFs tumble after PBOC’s rate cut disappoints markets
In response, the People’s Bank of China last Tuesday cut two more key lending rates for the first time in 10 months to lower borrowing costs for companies and households. The one-year loan prime rate, or LPR, was cut by 10 basis points to 3.55% and the five-year LPR, or the benchmark for mortgage rates, was lowered by the same amount to 4.2%, according to the PBOC.
The cuts are the latest in a string of moves by Beijing to shore up the wobbly post-pandemic economic recovery. The bank trimmed its seven-day reverse repo rate by 10 basis points to 1.90% from 2.00% last week. Meanwhile, the one-year medium-term lending facility, or MLF, was cut to 2.65% from 2.75%.
However, economists were disappointed because the flurry of interest-rate cuts was not an effective stimulus and amounted to “pushing on a string” as there is no credit demand among households or businesses who are allowed to borrow.
Papic told MarketWatch that China faces a potential “balance-sheet recession” due to a high debt-to-GDP ratio and a slowing property market. A balance-sheet recession, a term coined by Richard Koo, chief economist at Nomura Research Institute, is a type of economic downturn that occurs when high levels of private sector debt cause individuals or companies to collectively focus on saving by paying down debt rather than spending or investing, even when the borrowing cost comes down.
“That’s the problem with demand and there’s no way to fix this other than taking leverage on to the public sector,” Papic said. “You have to ensure that nominal GDP growth is high enough if you’re trying to de-leverage the private sector. If you do austerity, at the same time you’re de-leveraging, you will not reduce your debt because of the denominator effect. That’s what Chinese policymakers are going to be pushing.”
See: ‘Deep, lingering, persistent’ skepticism over China’s growth potential is keeping global financial markets from embracing its reopening
However, it doesn’t mean China’s recovery has been canceled as further monetary policy easing, fiscal stimulus and government intervention could be coming down the pipeline.
China’s State Council, which coordinates government ministries, last week discussed measures to spur growth in the economy, pledging to roll out policy steps in a timely way amid signs that a post-COVID recovery is fading, state media reported, without giving a timeline or details.
Papic said it is still too early to tell if the upcoming stimulus will be strong enough to stabilize the economy, especially given that the specific measures have not been announced yet.
But if they come up with what has been rumored in the past few weeks, such as removing purchase restrictions on property and lowering down payments in top-tier cities, further providing monetary support to accelerate home completions, and the issuance of one trillion special bonds, then he would expect growth to stabilize “at least in the next few months,” Papic said.
However, Shehzad Qazi, managing director at China Beige Book, said he thinks some of these steps would make little difference as some property restrictions will likely be pulled back in the coming months, but stabilizing residential real estate is “a far cry” from property reenergizing economic growth, he said in emailed commentary viewed by MarketWatch.
PGIM’s Bell and his team are still confident that significant economic growth will recover in the next six to 12 months as both monetary easing and fiscal stimulus will be “a lot larger” than the markets expect because the message to implement stimulus will be “permeated” from Beijing to all local government officials, so there will be “incremental additional coordinated policies” by the end of the day.
“If you add it up on a macro level, it could be quite large. So, with that in mind, I think we’re reasonably more optimistic than the market on the outlook for China, particularly in the fourth quarter,” he said.
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