The Year of the Dragon may have begun with a roar, but momentum in China’s economy has quickly faded throughout the year. While the first half of 2024 was buoyed by exports, price discounting and much stock building, this situation started to unwind in the second half, as illustrated by the monthly data reports. In addition, problems in the real estate sector continue to rumble on.
Data points from July and August suggest that the momentum slowed further on from Q223, when gross domestic product (GDP) growth slowed to less than 1% on a quarterly basis.
“Recent data suggests that growth in the review activities, including industrial production, retail sales and fixed asset investment, fell below market expectation in August,” says Hunter Chan, Economist, Greater China Economic Research at Standard Chartered. “The manufacturing Purchasing Managers’ Index has stayed below 50, partly due to recent typhoons disrupting production.” He also points to the housing sector and soft domestic consumer demand as the main drags on the economy.
Louis Kuijs, Chief Economist Asia-Pacific at S&P Global Ratings, agrees. “Economic growth has slowed because of a persistent downturn in the property sector and weak domestic demand generally amid low consumer and business confidence. While China is not in outright deflation, there is major downward pressure on prices and the risk of deflation has risen,” he says.
Exports are expected to start slowing down over the coming months, according to Sheana Yue, Economist in Oxford Economics’ China service. “In terms of the domestic sector, consumer sentiment remains downbeat,” she adds. “Plus, we still don’t know where the floor will be with the property sector, which is also weighing on households’ expectations.”
Structural concerns
While China’s economic slowdown is not a new phenomenon, the speed of the deceleration is, according to Alicia García-Herrero, Chief Economist for Asia-Pacific at French investment bank Natixis. “Before the Covid-19 pandemic, the main problem was the trade war with the US. But there are also structural issues within the economy,” she says, pointing to very low return on assets as a result of overinvestment for many years when China built and produced more than it needed.
“Another reason for the slowdown, which I don’t think is fully captured, is that labour productivity – thought to be very high – is decreasing year on year,” says García-Herrero. “Productivity is not declining, but the growth is very small. Similar to what happened in Japan previously, the low-end service sector jobs, such as convenience stores and e-commerce, are dominating labour creation. This is reducing labour productivity, which is why China is decelerating.”
China is also coping with structural headwinds such as challenging demographics and high domestic debt, in addition to rising restrictions on its international trade and investment links, according to Kuijs.
Consequently, there is much catching up to do for the economy to hit the official 5% GDP growth target. Yue is not convinced that it will grow as quickly as officials would like. “Our forecast is 4.8% GDP growth this year,” she says. “We think that consumption will continue to slow over the rest of the year and into early 2025.”
While S&P Global Ratings is expecting a slightly lower growth rate, at 4.6%, Standard Chartered also predicts 4.8%. Chan highlights emerging downside risks, such as a more cautious trade outlook in light of the escalating trade tensions between China and other economies.
“The US has imposed additional tariffs on the electric vehicle (EV) and semiconductor sectors, and is also likely to tighten restrictions on China’s access to high-end manufacturing and semiconductor items. Europe and other countries are following suit with additional tariffs on EVs,” he says.
As the Chinese government is also recognising the possibility of missing the annual growth target, Chan predicts a more supportive policy stance in the near term.
Providing incentives
While Yue isn’t expecting to see much fiscal stimulus, she does expect more monetary policy easing following the unexpected interest rate cut in July. “Cuts of 10 basis points are likely in both Q424 and Q125, which are incremental changes compared to those expected from the Federal Reserve’s easing cycle, or those already implemented by the European Central Bank and other advanced economies,” she says. “As such, the boost from the monetary policy side is not going to be massive.”
Government bond issuance is expected to increase in the second half of 2024, due to the need to fulfil annual quotas, but Yue doesn’t believe that this will deliver a big step up in terms of funding.
The government is also looking at how to better support the property sector. “There are rumours circulating – not confirmed yet – that there will be cuts to rates of existing loans, as well as allowing the refinancing of mortgages,” says Yue. “The Chinese mortgage system is distinctive, as refinancing mortgages isn’t permitted. While [cuts] would be helpful for the typical household, it’s not going to reverse the pessimism clouding the property sector.”
The authorities need to find a way to prop up home buyer sentiment, according to Yue. “The government realised that it had squeezed the property sector too much, and recent policy measures has loosened its grip. But it isn’t willing to completely let go due to concerns about leverage in the sector,” she says.
The government is looking at tweaking existing policies to support industries or sectors important for national security reasons, or where China can become a global champion in the future, such as the semiconductor and sustainability industries.
“The authorities have openly announced support for these sectors, which will be where most opportunities originate. However, areas where the authorities felt they had given too much leeway previously – such as the technology, tutoring and property sectors – will not be as dynamic as they were before,” Yue adds.
Other government support initiatives include the consumer goods trade-in programme, which increased retail sales, and the industrial equipment upgrading campaign, which encouraged investment in large-scale equipment.
In addition, the national strategy ‘Made in China 2025’ (MIC 2025) is focused on turning the country into a more innovative driven and high end manufacturing economy, which has resulted in relatively resilient manufacturing investment, according to Chan.
Yet tiny rate cuts or support for developers are small, unstructured tweaks, not comprehensive changes, such as measures to tackle deflation, argues García-Herrero. “This would require a much laxer country policy, which the government has not introduced,” she adds.
She believes that the Chinese government needs to announce an urgent set of support measures. “Yet there seems to be a paralysis in the policy-making. For example, it is Yi Gang, former head of the People’s Bank of China, urging action, not the current governor. No one in charge is sounding the alarm that this is a much worse situation than it looks,” she says.
“[The authorities] are not moving in the direction they should be, in terms of pushing consumption through a bigger stimulus, reforming the economy and protecting the private sector,” says García-Herrero. Subsequently, she believes that China will decelerate further.
Treasury operations
According to Damian Glendinning, Chairman of the Advisory Board at treasury consultancy CompleXCountries, a number of corporates have been developing a ‘China plus one’ strategy to increase growth potential, as well as protect operations from geopolitical turmoil.
“While China will continue to grow, it won’t be at the same rate as before. Therefore, many corporates are looking to hedge their bets by exploring other potential locations, such as India,” he says. “While corporates aren’t looking to shift their manufacturing out of China, they may opt for another country if they are planning to build a new plant.”
In addition to economic considerations, corporates have absorbed important lessons from the Covid-19 pandemic, such as the vulnerability inherent in long supply chains. “Companies are now looking to build resiliency within their supply chain by having more than one source for materials or components,” says Glendinning. “There is a definite rethink of supply chains taking place.”
He also points to mounting sustainability concerns. “Tripping three or four times around the world to make a single, fairly simple product may not be environmentally responsible,” he adds. “Plus, doing so has become very expensive as fuel costs increase.”
Many MNCs remain fully committed to the Chinese market. However, several trends are converging to transform the operating environment for treasury, including changes to tax and regulations, increased competition from local companies and, of course, the economic slowdown.
“Our business model relies on customer prepayments, which meant we haven’t needed to worry about cash flow. However, due to the reduced availability of public sector funding, we now offer credit or payment terms to customers. This impacts our credit scenarios and we have a risk profile that wasn’t present previously,” says a corporate treasurer from a European multinational company (MNC), who asked to remain anonymous.
“These issues have been keeping us busy throughout this fiscal year, but will also impact the start of the next fiscal year as well,” they add.
Most MNCs have a centralised funding and financing structure, so they borrow at the headquarter level and then put equity into China to operate the business. However, refinancing costs have gone up because of higher interest rates in the West, which is the reason many MNCs are pulling liquidity out of emerging countries to support the headquarter liquidity scenario.
“We’re now faced with relatively high refinancing costs, which is why we are focused on liquidity centralisation to support headquarters’ leveraged scenario,” says the treasurer.
As a result of the clamour around decoupling and de-risking, many MNCs are also worried about renminbi (CNY)-denominated asset FX risk exposure. “There is a lot of talk about how to de-risk this situation. In my opinion, this calls for a domestic set-up, because treasury needs to be sensitive and react to developments in the local market,” the MNC treasurer says. “The domestic team can keep headquarters informed and explore potential opportunities in risk mitigation and process optimisation.”
Notwithstanding decoupling and de-risking concerns, the European MNC is committed to the China market for the long term. But the in-country treasury team has to be prepared in case the situation evolves to a tipping point where they may need to operate independently.
Corporate treasury is experiencing both headwinds and tailwinds, according to the treasurer. In terms of headwinds, there seems to be greater control over cross-border fund flows.
While China permits cross-border cash pooling, Glendinning has heard from CompleXCountries members that new cross-border cash pooling applications are not being approved. “In 2013 [when China experienced a banking liquidity crisis], the authorities shut down cross-border flows to help the exchange rate and keep cash in the country. Currently, they haven’t tried to suspend the structures already in place, but new applications are not being approved,” he says.
“[Greater control over cross-border flows] impacts us, as we lend to headquarters on a regular basis to support liquidity centralisation,” says the treasurer. “Recent guidance indicated that a company must make a filing if the amount is above certain limits. While there’s no real restriction, it is an additional reporting requirement.”
In addition, China’s State Administration of Foreign Exchange now requires additional risk reserve surplus. “This is an additional cost, which may reduce our FX hedging effectiveness,” they add.
With regard to tailwinds, the MNC’s treasury has applied for a regional treasury centre (RTC) programme in Shanghai.
In the RTC scheme, the intention is to lower the tax at the transaction level in the CNY operating context to encourage cash flow into China. However, the programme has been under discussion for several years, without clear guidance as to the potential relaxation level that corporates could enjoy. Yet, the treasurer feels that it’s important to be part of the pilot and enter into dialogue with the government about their requirements to drive a win-win outcome.
Due to the operating environment, treasury is being pushed to mitigate structural redundancy as much as possible. As such, they are thinking about further streamlining efforts, such as pay and receive on behalf of, as well as a virtual account set-up to centralise liquidity at the lead entity level in China.
Maturing function
There is a major shift in skill sets and mindset required for a treasury role in China. Traditional operational experience is not enough anymore, as a treasurer needs a strategic outlook to understand the changes in the local market and how that relates to the global market, as well as the sector’s business dynamics.
A treasurer also needs to have a good technical perspective, particularly artificial intelligence (AI). The MNC treasurer is already using robotic process automation in their payment factories in China, for example, and looks forward to using AI capability in their day-to-day work.
They believe that AI can remove a lot of repetitive, low value-add activities, which allows the treasury team to focus on more strategic analysis. Longer-term, they think it will change the cash flow forecasting capability in the corporate environment.
“Currently, we have to collect data from different functions and business lines to do the forecast. There is much inefficiency in the current set-up, but if AI can capture the information within the systems and allow us to react in real time, then it could improve our decision-making process,” they explain.
The treasury is also thinking about further enhancing its onshore infrastructure to centralise and reduce liquidity redundancy at every entity level. “We never get bored – there’s enough to keep us busy for the foreseeable future,” they add.
Likewise, the role of the treasurer within a Chinese company is evolving simply because of the growing operational complexity, according to Glendinning.
“Many Chinese companies, including state-owned enterprises, now have extensive operations outside of China and they’re discovering that having one person in accounts look after treasury in between making their ledger entries doesn’t work anymore,” says Glendinning, who was previously group treasurer at Chinese technology firm, Lenovo. “There is an inevitable evolution and some of the most sophisticated treasuries are in Chinese companies.”
The Year of the Snake will be a pivotal one for the country as its MIC 2025 initiative, which strives to secure China’s position a global powerhouse in high-tech industries, comes to fruition. However, Standard Chartered believes that the country’s GDP growth is likely to slow further, dropping to 4.5% in 2025.
Looking further out, Chan believes that the overall ageing population in China is likely to be one of the factors to weigh on long-term growth. “But on the other hand, if we read the long-term growth model in a classic economic way, technology enhancement also plays a part,” he says. “So the government needs to be transitioning to a growth model that is innovation and data driven to boost the long-term perspective.”
