China risks a protracted slowdown without significant stimulus

China’s structural economic challenges persist. The property sector has continued to deteriorate — housing construction and sales have slowed sharply and house prices across the country have fallen an average of 20% since 2021. The implosion of the property sector, which accounts for 70% of household wealth and 20-30% of China’s economic activity, has weighed on sentiment. However, other factors, including increased government intervention in the private sector have also eroded sentiment and contributed to subdued domestic demand.

Weak domestic demand and an expansion of capacity in the manufacturing sector has increased the risk of a deflationary spiral developing. Factory-gate prices have been falling since late 2022 while annual headline and core inflation remain below 1%. Data for September revealed a continued slowdown in inflation due to deficient domestic demand. Deflation raises real interest rates if nominal interest rates remain unchanged. Higher real rates increase debt burdens and slow growth further. This is highly relevant for China because local governments, state-owned enterprises, and households have racked up significant debt over the last couple of decades — the gross national debt-to-GDP ratio is close to 300%. A debt-deflation spiral could significantly complicate China’s already troubled economic outlook.

Exports have been the rare bright spot in the economy, but external demand is also likely to come under pressure as several developed economies raise trade barriers to counter China’s subsidies for goods such as electric vehicles. In recent months the European Union and the United States announced sharp increases to tariffs on China’s electric vehicles. Trade data for September indicates that China’s overall exports are already beginning to come under pressure as manufacturers slash prices to reduce inventory ahead of tariffs taking effect. The threat of trade frictions, coupled with a weak economic outlook, has contributed to a slowdown of foreign direct investment (FDI) into China. Net FDI as a share of GDP has been negative since mid-2022 and official data indicates that the outflow of FDI accelerated in the first half of 2024 (Chart 1).

Chart 1: Net inflows of foreign direct investment to China (% share of GDP)

Source: IMF, World Bank, OECD

These complications have increased the need for urgent government intervention in the form of fiscal stimulus. However, support has been piecemeal. A spate of stimulus measures in late September included lower policy interest rates, measures to reduce the stock of unsold housing inventory, and funding to support the stock market. This was followed by promises of more forceful fiscal support which sent China’s stock exchange soaring after several months in decline. However, the stock market has see-sawed since then as plans to boost the economy have remained cryptic. First, the National Development and Reform Commission failed to provide clear-cut plans of fiscal stimulus, then China’s Ministry of Finance hinted at increasing central government debt issuance to boost the economy but stopped short of announcing a spending plan. Attention now shifts to the National People’s Congress, which is expected to meet later this month.

In the absence of aggressive fiscal intervention, China risks falling short of its 2024 growth target of 5%. Policymakers are likely to take a cue from GDP data for the third quarter of 2024, due to be published at the end of the week. Current measures could provide temporary respite in coming quarters, but they are unlikely to be sufficient to reverse the underlying issues of weak sentiment and underwhelming demand. However, bold fiscal intervention could be smothered by elevated debt and impeded by a steady shift in focus away from growth.

Unfortunately, there are no easy answers for China. The country grapples with underwhelming demand in the short term and broader supply-side challenges in the long term. For instance, China’s population is projected to shrink over the coming decades due to ageing and very low fertility rates. Many have compared China’s current situation to Japan’s plight in the 1990s when the weight of structural challenges and asset bubbles resulted in growth slowing to a trickle. Time will tell.

This newsletter was distributed on 17th October 2024. For any questions/comments on this week's newsletter, please contact our authors:

This blog was co-authored by Lester Gunnion, Manager at Deloitte Access Economics

Click on the links below to read our previous Weekly Economic Briefings:

• Housing market: lots of pain, not much gain (09 Oct)
• Retail Holiday Report: Charting a course for growth (01 Oct) 
• Job vacancies falling (26 Sept)
• Australia's population surge eases: The focus must shift to productivity (19 Sept)