The writer is chief economist for the Asia-Pacific at Natixis and senior research fellow at the Bruegel Institute
The sudden and immediate reopening of the Chinese economy after three years of zero-Covid policies on December 8 last year was accompanied by a rapid positive turn in foreign investors’ sentiment, leading to a surge in portfolio flows, especially equities. This shift was based on the experience of other economies’ pent-up post-pandemic demand. Yet China seems to be following a different pattern.
While China’s services demand has been resilient, the sales of consumer durables have been disappointing, largely dragged down by cars. Fixed-asset investment is an important contributor to growth, but it grew only 4.7 per cent in April 2023, which is lower than the 2022 average. This is not only true of shrinking real estate investment because manufacturing investment is also growing more slowly than last year, when China had a countrywide lockdown.
China’s contracting purchasing managers’ index data for May also confirms the negative sentiment on manufacturing, which should not be surprising given that industrial profits have plummeted in 2023, with close to 20 per cent negative growth in April.
Although the poor performance of the manufacturing sector and its divergence versus services is a global problem, China’s case is particularly important because it is the world’s largest exporter. Its global manufacturing export share is more than 20 per cent.
One could be tempted to argue that the reason for the poor development in China’s manufacturing capacity is flagging external demand, especially from the US and Europe. However, the trade data offers a very different picture. China’s exports grew 8.5 per cent in April, even with a rapid deceleration of the US and European economies, while its imports plummeted by almost 8 per cent. The reopening of China’s economy was widely expected to unleash the excess savings that had accumulated in bank accounts during the pandemic. This has not transpired.
Against such a backdrop, what was considered an underwhelming growth target of 5 per cent for 2023 when announced at the Communist party’s main gathering in March, is now perceived as increasingly challenging.
In fact, the People’s Bank of China has been pushing banks to lower their deposit rates in order to entice consumers to spend, though it has barely cut either its reserve requirement ratio or its official rate. No big announcement to support the economy has been made on the fiscal side either. The most likely reason for such caution is the rapidly increasing public debt, which has hit 97 per cent of gross domestic product — and still excludes state-owned enterprises’ debt because of data constraints.
The widened US-China yield differentials and worsening growth prospects, coupled with a depreciating yuan, are putting investors off a market that was expected to be this year’s darling. In fact, net portfolio flows turned highly negative in April, especially for equities, according to the Institute of International Finance.
This contrasts with the idea that the easing of regulatory constraints on property and large tech companies would push the stock market up after the harsh government crackdown on both sectors since 2020. Instead, the stock markets of China and Hong Kong are flunking, as a result of negative market sentiment.
Down the road, the question is whether peaking rates in the US, while the American economy heads towards a recession, will be enough to reignite foreign investors’ interest in Chinese capital markets. The reality is that, beyond cyclical reasons, a whole new set of risks are emerging from America’s push for technological containment and the threat of western sanctions on China, either because of its support for Russia or what might unfold in Taiwan. In addition, China’s newly amended law against foreign espionage exemplifies its increasing wariness when it comes to foreign investors.
China’s hesitant recovery, its push for lower interest rates and its poor corporate profits are all deterring foreign investors. The gloomy outlook in terms of portfolio inflows is surely another important reason for it to guard its large trade surplus, even while the US and European economies head towards recession. This also means China will continue to push exports while exerting restraint on imports to protect its foreign reserves from what are, by now, pretty unavoidable portfolio outflows.
