Economic Letter from Asia: Some Perspectives on China

China watchers saw reason for some cautious optimism lately, as economic data for August showed signs of growth stabilization. Retail sales and industrial production expanded at a brisker pace, while trade registered reduced rates of decline. Growth in fixed asset investment, however, continued to slow. Additionally, China’s latest PMI readings for September were a mixed bag, as official readings indicated some pick up in non-manufacturing activity, while the Caixin gauge signaled slower growth in both manufacturing and services. Looking further back, China’s GDP growth in Q2 fell short of expectations, as a much-hyped post-pandemic rebound disappointed. Instead, the Q2 growth reading was supported by low base effects from a year ago, during which China enforced strict pandemic-related lockdowns. Regardless, China’s growth for the year has been predominantly consumption-led, while trade acted as a mild drag (chart 1).

China’s latent consumption boosters Looking ahead, household consumption in China may still have legs for further growth, especially if latent drivers are unleashed. For one, China still has much to recoup from the domestic tourism losses incurred during the pandemic as locals start to fully resume their inter-city holidays. Domestic urban tourism arrivals have already recovered in H1 this year to about 84% of pre-pandemic levels (H1 2019), with China’s Tourism Academy expecting domestic travel revenues to reach 80% of pre-pandemic levels in 2023. Another latent consumption driver lies in China’s swelling household deposits, which have surged by about 62% since the onset of the pandemic to reach values equivalent to nearly 110% of China’s nominal GDP for 2022.

With that said, and despite some anticipation of “revenge spending” wrought by a drawdown of elevated savings, China’s household deposits continued to grow with the reopening of the economy, albeit at modestly declined rates. The absence of a consumption revival led by reduced savings suggests that other factors – possibly those relating to dampened consumer and investment sentiment – may be at play.

Positive externalities from China’s recovery The potential benefits of a robust Chinese recovery are immense, with corresponding positive externalities likely to be reaped through numerous channels. For instance, Chinese tourists remain a largely-dormant well to be tapped upon for inbound revenue, given how their overseas travel activity have hitherto been sluggish amid lingering uncertainties at home. A stabilization of China’s domestic economic situation, coupled with some yuan recovery and an eventual easing of temporal travel-related frictions could coax more Chinese travelers into taking trips abroad. Tourism-reliant economies who have yet to experience a big Chinese tourism recovery – such as Thailand – would stand to benefit the most from this scenario.

Tourism aside, Asia Pacific economies also stand to gain from renewed import demand from China, should the latter’s domestic situation recover sufficiently to rev up the consumption of foreign goods and services. Despite some gradual shifts seen over recent years, many Asia Pacific economies still bear significant export exposure to China (chart 4). Specifically, about 33% of Australia’s exports and about 28% of New Zealand’s are shipped to China, while Indonesia’s exposure has risen to about 25%, from just 9.2% in early-2015. In contrast, India has seen its export exposure to China gradually decline, to about 3.5% in July, from 6.8% in early-2021.

Persisting headwinds Barring the aforementioned supports to growth, China continues to grapple with a spate of near-term challenges, both domestically and overseas. Externally, China is suffering from a deteriorating trade surplus, which has been pulled down by diminishing imports from major trading partners such as the United States and the European Union. China is also reeling from a deterioration of its terms of trade, brought about in part by higher energy costs (chart 5). An additional – and more recent – sources of price pressure stems from food prices, as El Nino effects threaten crop yields globally. China is not alone, however, in its import price predicament, with other Asia Pacific economies, such as South Korea and Malaysia, facing a similar squeeze.

Apart from trade-related matters, China faces added challenges from dwindling foreign direct investment (FDI) and persistent foreign portfolio outflows. This is indicative of the cautious outlook on the economy from external investors. Specifically, China’s rolling 4-quarter net FDI inflows have shrunk by more than 80% since end-2021, while corresponding portfolio flows have logged persistent net divestments since Q3 last year (chart 6). More recently, China’s non-banking sector suffered a capital flight of $48.9 billion in August – the largest monthly outflow since December 2015 – of which $16.8 billion were net FDI outflows and $29.4 billion were net portfolio divestments.

Internally, China continues to confront persistent weakness in its real estate sector, with major property developers like Evergrande and Country Garden still struggling with debt and liquidity-related woes. Sentiment toward the sector has become increasingly negative since the onset of the property crisis in 2021, with investments into and sales of Chinese real estate turned increasingly subdued over the period. Zooming out, China also runs a real risk of a broader supply-side issue: it already has more homes than people to live in them.