The Flanders-China Chamber of Commerce and KBC Group – with the support of Flanders Investment & Trade – organized an in-person event on November 16, 2023 in Gent, with Mr Hans Dewachter, Chief Economist, KBC Group, who gave a presentation on China unique recession.
What is meant by “unique recession”. It is a balance sheet recession or a period after an asset bubble burst and the private sector deleverages. Looking at the macro-economic context, we see a decade plus of slowdown. China's incredible growth story over the past 25 years allowed the economy to expand rapidly, catching up with the largest economies in nominal terms and seeing incomes rise significantly. However, China is still solidly a middle-income economy and has a long way to go to catch up with wealthier economies. The double-digit growth rates of the nineties and early aughts, however, are clearly a thing of the past. The economy has been slowing for more than a decade, reflecting the fact that those growth figures were not sustainable. The question now is where China's potential growth rate will stabilize. China bears see structural factors as proof that potential growth will continue to decline, leaving China in a middle-income trap and long-run economic malaise. The more positive outlook is that China's economy has several unique advantages, and the right policy can support higher growth levels that close the gap with the U.S. and other wealthier economies. The demographic situation, which was already set to weigh on China's potential growth, has deteriorated further in recent years. While industrialization and investment supported the double-digit rates of the past, the intervening years saw some rebalancing from industry toward services, with a higher contribution from consumption. Industrial upgrading and higher quality growth became policy mantras, but the reba;lancing has since been interrupted in the Covid years.
Subpar growth is enough to hit the target. A lot of attention is given to the official growth targets, but they were not particularly ambitious in 2021 or 2023, despite expected reopening bounce backs. Missing the 5% target would have been a very bearish signal, but reaching or just surpassing it does not tell us much about future momentum or the overall health of the economy. Stripping away the negative GDP deflator, we see that nominal GDP grew only 3.5% year-on-year in Q3 2023 versus an average of nearly 9% between 2015 and 2019. Other data also point to some weakness. It is not only the quarterly data that have been choppier since the pandemic. Industrial production and retail sales have bounced around quite a lot in recent years, and they are generally weaker than the very stable seen pre-pandemic.
Real estate continues to suffer. Price data in the real estate market suggest resilience but may be distorted as it is based on surveys rather than published transaction data and because price controls from 2016 helped distort (and keep flat) prices for pre-sales. But it's clear that transactions and investment in real estate have dropped significantly. Though there were initial indications of stabilization toward the beginning of the year, developers are still running into problems, and the market is still weak.
Inflation is in the doldrums. Deflation has become a flash point for concern this year. While the collapse in headline inflation is due to non-core items (energy and food), core inflation continues a multi-year decline, reflecting years of subpar growth.
Evidence of a balance sheet recession. Richard Koo coined the term in reference to japan's economic stagnation in the 1990s. He also argued that the world faced a balance sheet recession after the GFC. Is China in one? Overall leverage of 'private' non-financial sector at elevated levels. Debt of Chinese households at levels of advanced economies as households took out mortgages and helped fuel the real estate sector. Household debt has risen sharply in China as households took out mortgages and helped fuel the real estate sector. Pessimism isn't limited to the real estate sector though. Importantly, the pandemic-era impulse to save more has not unwound in China like it has in other economies. New household bank deposits have surged, worsening the tendency of Chinese households to over-save, especially compared with other economies. There are sign of household deleveraging, with loans to households and loans for real estate dropping, especially compared to loans to corporates. The total credit impulse remains subdued.
What are the financial stability risks? The exposed banking sector faces significant headwinds as lending growth decelerates and asset quality deteriorates against the backdrop of the expanding real estate crisis and the increasingly difficult position of LGFVs.
What is the policy path forward? Monetary policy. Though monetary policy is not currently a very effective tool, there is not enough evidence to suggest China is in a liquidity trap. Interest rate cuts haven't helped boost credit growth, but the cuts have been very moderate, especially in the context of extremely weak inflation. Lower interest rates are squeezing banks' NIMs, while exposure to the real estate sector remains non-negligible. Fiscal policy. The standard policy prescription for a balance sheet recession is not straightforward in the case of China, where the quasi-public sector is also highly leveraged. Using the quasi-public sector to support growth via debt-fueled investment is not new in China, yet growth outcomes remain generally disappointing, suggesting declining efficiency of this tactic. Augmented estimates of public debt and deficits highlight the strong fiscal impulse already in place in China. LGFVs are running into financing problems and SOEs are less and less efficient, suggesting reforms are increasingly necessary. The central government runs a substantial budget surplus, suggesting there are other ways for the government to step in and support growth. Direct support to households and the private sector, as well as key reforms to the social safety net, could go far for boosting confidence. Household registration reforms could confer more protections and access to social services to migrant workers. Further SOE reform combined with clarity on private sector regulations could improve confidence.
Conclusion: The initial conditions of the Chinese economy clearly point to increasing risks of a balance sheet recession, but extrapolating is dangerous. China can count on “special” powers that go well beyond the standard toolbox of market economies. Whether it will do so, remains an open question, Mr Dewachter concluded.
