China: growth outlook

China: growth outlook

China’s economy grew by a surprising 3.9 percent in the third quarter. This represented a clear recovery compared to growth of 0.4 percent in the previous quarter. The year started off well with 4.3 percent growth in the first quarter but then started to falter.

Sentiment throughout the country has dropped due to the zero-Covid strategy and the repeated lockdowns. The 20th Party Congress did not give any indication of a change in policy on this front. Compounding the situation are the harsh state interventions in the technology and real estate sectors together with measures to reduce emissions and contain financial risks, which are also keeping the lid on growth. Altogether, these measures have had a considerable impact on the investment climate for private enterprise and foreign investors. The Party Congress also clearly set the course for a permanent strengthening of the state economy.

The deteriorating prospects for the global economy are also increasing the pressure on China’s economy. Russia’s war in Ukraine has sent inflation soaring worldwide and reduced purchasing power in China’s main export markets. Exports served as a stabilising factor for China’s growth during the pandemic so declining demand here increases the risks still further. Central banks, above all the US central bank, have responded to the situation with rapid interest rate hikes, which trigger capital outflows as investors seek safe havens, putting downward pressure on the Chinese currency.

So far, China’s political decision-makers have targeted the supply side with their economic measures, mainly aiming to strengthen high-tech production, promote innovation and increase infrastructure expenditure. The current measures are primarily geared towards the Communist Party’s long-term strategic objectives of modernising the economy and reducing its technological dependency on the West. However, consumption and private investment will not improve without a fundamental change in policy. The increasing economic uncertainty is making households and enterprises noticeably cautious about spending.

Without a fundamental policy turnaround, the country’s economic policy will increasingly frustrate the private sector and the middle classes. However, there are no signs of a return to a more pragmatic economic policy approach. Instead, further ideologically motivated measures and an expansion of state capitalism seem to be on the agenda. This will have a negative impact on the efficiency of capital allocation and considerably reduce China’s long-term growth prospects.

The Chinese economy is therefore likely to post a disappointing performance in 2022, far below the already abandoned target growth of around 5.5 percent. In the first three quarters of the year, the Chinese economy expanded by three percent, which has prompted the large banks to downwardly revise their growth forecasts again for the year overall and for 2023.

Construction recovers while services remain weak

Construction activity posted the strongest recovery, rising 7.8 percent in the third quarter compared to the previous year. Manufacturing grew by four percent and services by 3.2 percent. It should be said, however, that a large proportion of this upward trend is due to the low base level of last year’s figures. In the third quarter 2021, for example, construction activity dropped 1.8 percent.

The low growth of the service sector continues to be a weak point in the economy and only improved marginally in the third quarter. IT-related services, which have long been a major driver of growth in the service sector, grew by 7.9 percent year on year, after 7.6 percent growth in the second quarter. The sector is still far behind the growth of 21.7 percent seen in 2019 before the pandemic and the harsh interventions of the government in the Chinese technology sector.

The weak economy is also burdening the country’s public finances. Expenditure for healthcare services related to the implementation of the stringent Covid measures and to the growing costs of easing the pressure on the labour market is rising. The key sources of revenue are faltering. Revenue from corporate income tax rose 2.1 percent, its lowest growth in almost two years, while revenue from real estate sales was down 8.9 percent in the third quarter compared to the previous year.

Industrial activity remains a major driver of total GDP growth. In the third quarter, industrial value added grew by 4.8 percent compared to last year. Growth in the manufacturing sector was 4.1 percent on average which is its strongest quarterly performance since the second quarter 2021, buoyed by a 6.4 percent growth surge in September. The government’s focus on stimulating supply and measures to minimise supply chain disruptions seem to be paying off for the time being.

The high-tech industries are a consistent bright spot and recorded particularly good results in September. Value added here no longer hit double digits, but was nonetheless 9.3 percent higher than in September 2021. In the third quarter, production growth in vehicle manufacturing averaged seven percent, in electrotechnology and mechanical engineering 14.4 percent and in electronic products 7.8 percent compared to the same period last year.

Confidence among manufacturers and service providers fell at the end of the third quarter. The Caixin purchasing managers’ index for manufacturing stood at 48.1 in September, and the PMI for services dropped from its high level of 55.5 in July to 49.3 in September.

Foreign trade and trade surpluses rise steeply

Exports remain an important pillar of the economy even though the pace of growth here slowed in the third quarter. The growth of exports in US dollars dropped from 17.9 percent at the end of the second quarter year on year to 5.7 percent in September. Despite the slower pace of growth, China still exported goods worth 322 billion US dollars in September, not far off the all-time record of 340 billion US dollars posted in December 2021 and well above the pre-pandemic level of 218 billion US dollars in September 2019.

Rising inflation and reduced growth prospects in key export markets have not yet had a tangible effect on the demand for Chinese goods. Exports to the EU increased by 16.9 percent in the first nine months of 2022 while exports to the United States and the ASEAN region rose by 8.9 percent and 20.6 percent respectively in the same period.

Vehicle exports hit a new high as Chinese enterprises strive for global expansion, particularly in electric vehicles (EV). In the first nine months of 2022, auto exports soared 64.6 percent to a new record level. China has now overtaken Germany as the world’s second largest vehicle exporter after Japan.

Imports recorded a minimal growth of 0.3 percent in September year on year and growth of 4.1 percent in the first nine months of the year. Apart from raw materials, China’s demand for goods produced abroad is low. Auto imports dipped 0.6 percent and imports of machinery fell 12.3 percent.

The discrepancy between exports and imports has led to an ever-increasing trade gap. China’s trade surplus reached 101.3 billion US dollars in July which is a record monthly result. In September, it went down to 84.6 billion dollars, but this is still a record level.

China: foreign trade*

350

300

250

200

150

100

50

0

-50

-100

2018

* in billions US dollar Source: Macrobond 2019 2020 2021

Trade surpluses Exports Imports 2022

Economic support measures needed

The government’s economic measures, including cheaper loans, are fuelling investment in stateowned enterprises (SOE). These picked up momentum in the third quarter, rising by 10.6 percent by the end of the quarter compared with an increase of 9.2 percent at the end of the second quarter.

Infrastructure investment gradually gathered pace after the government announced an infrastructure plan in July with a price tag of 6.8 trillion Chinese yuan. Infrastructure investment rose 8.6 percent in the first nine months of the year, reaching its highest level this year so far. However, the impact of higher infrastructure investment cannot offset stagnating real estate investment.

Consumer prices still moderate while producer prices return to normal

Consumer inflation accelerated in the third quarter and reached 2.8 percent in September year on year, the highest monthly increase since April 2020. But this is still only marginally higher than the five-year average of two percent. Annual inflation is below the annual target of three percent. Rising prices are not a major issue for the country’s political decision-makers as they are planning further economic measures.

Since the beginning of the Russian war in Ukraine, China has also seen energy prices rise. Prices peaked in the second quarter before dropping again in the third quarter. The monthly increase in fuel

prices for vehicles was down from 32.8 percent in June year on year to 19 percent in September, and energy costs for industry had increased by 29.4 percent in June year on year before dropping to 14.3 percent in September.

The producer price index (PPI) has been on a downward trend for eleven months and was 0.9 percent down in September year on year. The decrease in prices is due to the globally falling commodity and energy prices as well as the ongoing low demand in the economy. The economic measures have so far not pushed prices up in the construction sector.

Labour market is stable but youth unemployment remains problematic

The persistently weak level of consumption in the services sector and in retail as well as the slowdown in the real estate and technology sectors are having a tangible impact on the labour market. The manufacturing sector presents a more mixed picture in which the automotive sector, mechanical engineering and electronics are the shining stars that together created more than one million new jobs up to 2022.

The number of newly created urban jobs is set to reach the target for the year of eleven million after already passing the ten million mark at the end of the third quarter. 2022 is nonetheless still likely to be the worst year for job creation since the start of the pandemic in 2020.

Unemployment in the cities is at a stable level, coming in at 5.5 percent at the end of September, a slight increase on the August level of 5.3 percent. Youth unemployment, however, reached a new alltime high of 19.9 percent in August. This had dropped to 17.5 percent by the end of the third quarter but is still high, due to by the record number of new university graduates entering the labour market.

Retailers under pressure

Until the end of September, around 30 million people were still affected by some form of lockdown. The unpredictable nature of the measures and the lack of an exit strategy are preventing any significant improvements in retail sales. Sentiment is at a record low and consumers are opting to save rather than spend.

Retail sales did continue to grow in the third quarter but are still very vulnerable. In August, growth reached 5.4 percent, its highest rate since January, but then dropped to 2.5 percent in September. Consumers’ fear of being affected by a lockdown is reducing spending on hotels and restaurants in particular.

Local governments are dispensing vouchers and subsidies to help kick-start consumption. But consumption is not the top priority of the state’s economic agenda which continues to focus on manufacturing and investment.

One of the few bright spots was the recovery of auto sales, propelled by state incentives including subsidies for electric vehicles. Auto sales increased by 13.2 percent in the third quarter compared to the same period last year.