The Chinese economy appears to be decelerating somewhat. In our view, the most likely scenario is that the economy shifts down to a pace of growth in 2022 that is roughly in line with the economy’s potential, of around 5% to 6%.
It is possible, though, that some of the vulnerabilities in the Chinese economy worsen unexpectedly and so threaten economic growth. This is where carefully calibrated policy responses will be needed. The track record of the authorities in mainland China has been quite good, which is why financial markets have not taken fright at its economic trajectory.
The key drivers of the economy have lost momentum. Growth in fixed asset investment slowed to 8.9% between January and September 2021 compared with the same period in 2020, falling back from 10.3% between January and August 2021.
The slowdown in consumer spending was even more marked, with retail sales growth plunging from 8.5% in July to just 2.5% year on year in August, the slowest pace of growth in a year. The purchasing manager survey for manufacturing indicated that the sector had contracted.
Once one-off factors that created headwinds – such as public health measures – are removed, the economy can regain its verve quickly
Sound fundamentals
However, we should not be unduly alarmed. Exports have maintained strong momentum, while there are signs in the survey of non-manufacturing purchasing managers that the services sector bounced back in September after contracting in August. In other words, once the restrictions put in place to contain new surges in Covid-19 infections were eased, mainland China’s services sector was able to bounce back rather quickly.
This suggests that the fundamentals of the economy remain sound, and that once one-off factors that created headwinds – such as public health measures – are removed, the economy can regain its verve quickly.
Downside risks
This is one reason why the authorities have not rushed to stimulate the economy by ramping up public sector spending and encouraging bank lending as they used to. Still, there are some downside risks that could hurt economic activity:
- Private sector businesses have been rattled by the regulatory crackdowns on big technology companies and selected sectors such as tuition services and cosmetic surgery. The authorities saw regulatory reforms as necessary to rectify social ills and economic distortions such as the lack of competition or fair treatment of consumers. But the suddenness of the policy changes could dampen the spirits of private enterprise, and this may cause some weakening in private investment spending.
- Policymakers have pressed local governments to take serious action to cut greenhouse gas emissions. This has prompted several provinces to order cutbacks in power generation and production operations in a few sectors where decarbonisation efforts have been disappointing. Combined with shortages of coal, the resulting power outages could hurt production activities in the near term.
- The real estate sector is at risk from the fallout from the financial stresses that many large developers have been enduring. Real estate activities account for as much as 20% of economic output if the sector’s direct and indirect impacts are factored in. Given its outsized footprint in the economy, a sharp property slowdown could undermine the country’s wider economic prospects.
Ready to act
While these risks are real, policymakers are aware of them and have the tools to respond quickly and effectively should the slowdown worsen. For example, as part of its strategy of reducing leverage in the economy, the central bank has kept a tight leash on bank lending; this can be eased for a few months if the economy shows weakness.
Similarly, local governments were told to be more restrained in their public investment programmes because of mismanagement in earlier years. This policy, too, can be eased to strengthen infrastructure investment in the economy if necessary.
Indeed, the increase in local government bond issuance in recent months suggests that there will be a pickup in investment that could help support the economy. The government has also held back from fiscal pump-priming this year, so it has considerable policy space to step up spending to boost the economy.
In short, the Chinese economy is facing several headwinds which increase the downside risks to economic growth. But a close reading of the economy suggests that the broad fundamentals remain strong. A judicious set of policy responses should therefore suffice to keep economic activity on a sound track.
