Who knew that an eyebrow pencil would be a measure for the state of the Chinese economy? Amid various economic updates and projections about China’s recovery since the Covid-19 pandemic, it was one social media influencer’s throw-away comment that gave an insight that no econometrics could.
When people complained that an eyebrow pencil was too expensive at 79 yuan (~US$10), influencer Li Jiaqi said that if people couldn’t afford it, they didn’t work hard enough. The backlash was instant, and the BBC reported how this hit a raw nerve among China’s youth who are struggling in an economy that has stumbled since Covid.
Dan Wang, Chief Economist at Hang Seng Bank (China), says job losses have been a major issue and the worsening job security has been a source of anxiety in China. “The economy is in a very uncertain and depressed state, but it is still growing,” Wang explains. “The Chinese economy is slowly recovering – it is not getting worse, it is getting better – but it is not getting better fast enough and people are getting worried because of that.”
The World Bank’s most recent projections highlight China’s ‘fading bounce back’ from the re-opening of its economy since the pandemic and the weakness in the property sector, as well as high levels of debt as persistent issues. The World Bank projects that gross domestic product (GDP) growth will be 4.4% in 2024. This was a reduction from a previous estimate of 4.8% and is China’s slowest growth rate in decades.
Likewise, S&P Global Ratings economists for Asia Pacific Louis Kuijs and Vishrut Rana cut their forecast for 2024 from 4.8% to 4.4%. For 2023, they cut their growth forecast from 5.24% to 4.8%. They explain that because government spending was less than expected in July, and exports slowed due to weak global demand, “China’s post-Covid recovery has consequently lost steam. Industrial production growth has remained subdued. While consumer spending on catering, travel, and other services has remained robust, goods consumption has slowed.” Despite the seemingly negative outlook, the S&P analysts write, “We don’t think the outlook is alarming.”
Commenting on data from the third quarter of 2023, Bruce Pang, Chief Economist and Head of Research, Greater China at JLL, says that China’s recovery had regathered pace and was on a more secure footing, which was helped by consumers splurging over the summer. “However, it doesn’t mean policymakers can take a breather. As the economy is turning into a soft landing from a slippery slope to the recession, new remedies should be used to cure the déjà vu: unbalanced recovery; doldrums, and weakened growth,” Pang tells Treasury Today Asia.
Pang adds that the government has lately signalled a pivot to a more ‘pro-growth, pro-business mindset’. “The key policy priority will be how to boost domestic demand. In the most optimistic scenario, the government will engineer a gradual transition to slower growth with more balanced development across sectors,” Pang says. “The key is to maintain the shape and pace of the economic recovery so that companies are willing to continue investing and residents are willing to continue consuming, forming a virtuous cycle and a balanced recovery. Fiscal and industrial policies rather than monetary stimulus would be needed to keep the recovery on track – just not ‘big bang’-style policy spurs, but in a gradual and persevering way. It will take time for recent policies and measures to take effect and to improve housing sales and eventually, property investment,” Pang explains.
It is the property sector that has been the source of many of China’s woes and has been very visible to investors and China observers. The S&P Global economists note that the property downturn has weighed on China’s growth. “With house prices falling again, the property downturn has also affected already weak consumer and business confidence. The downturn has also squeezed local governments’ spending amid weak land revenues and financial strains.”
In September 2023, analysts at Fitch Ratings said that the housing market hadn’t stabilised, as was previously hoped, and they predicted that new sales could fall by 20%. They noted the importance of the property sector overall to China’s economy: “Housing is a third of investment and 12% of Chinese GDP and has strong multiplier impacts on the wider economy.”
With home ownership accounting for a substantial portion of people’s wealth, Chinese people are now poorer as the value of their homes has slumped. Alicia Garcia-Herrero, Chief Asia Economist at investment bank Natixis, was quoted by the BBC as saying, “In China, property is effectively your savings. Until recently, it seemed better than putting your money into the crazy stock market or a bank account with low interest rate.” It was expected that consumers would ramp up their spending after being released from Covid lockdowns, but this – because of the drop in property values – didn’t happen.
A visible sign of the problems in the sector have been with Evergrande, the property giant that has been on the brink of collapse, and whose problems continue to put it in a state of crisis. It was late on its debt repayments in 2021 which, because of its size – with debts of US$300bn – sparked fears of a wider crash. This occurred after the central government’s ‘three red lines’ policy (which capped debt ratios to cash, assets and equity) that sought to rein in the borrowing of property developers and prevent the sector from overheating.
Since then, the property market has slumped, and now there are signs of recovery. S&P Global Ratings, in its ‘China Property Watch’ report expects there will be a slow recovery in 2024. S&P Global primary credit analysts Ricky Tsang and Esther Liu write that China home sales will remain low, with China property sales for 2023 dropping an estimated 10% to 15% and 5% in 2024. “The good news for China’s property developers is that a bottom is in sight,” the analysts write. “The bad news is that the sector will likely bump along this floor for years.”
Tsang and Liu expect to see a difference in the recovery between the first-tier cities, which are supported by the government’s policy. Meanwhile, “Lower-tier cities are contending with excess supply and depleted confidence,” they write. They also note that there will be a divergence between the state-owned developers – which have been focused on upper-tier markets – and the private developers, which are struggling to borrow particularly as a number of developers (not just Evergrande) have missed repayments on their debt.
When I talk to clients, I explain that China is not nuanced – it is just simply different, and critically so.
Peter Alexander, Managing Director, Z-Ben Advisors
S&P Global puts the property sector in context by dividing up recent history into three phases. They argue that China’s property market is reverting back to the sales levels of its ‘stable’ period. They divide the history into three stages, with the first being 2009-2015 – its stable period – which followed the global financial crisis. Phase two was a bubble, which lasted between 2016 and 2021. And the current phase is from 2022 to the present day, which began with the government’s intervention and ‘three red lines’ policy that put developers on a ‘debt diet’. The analysts write: “The lesson for us is that policies come and go, and sentiment ebbs and flows. But the relatively drama-free first period is perhaps the mean to which things will ultimately revert. We view it as a kind of baseline.”
Peter Alexander, Managing Director of Z-Ben Advisors, who has been in China for over 30 years, has witnessed many vicissitudes in the Chinese market. “I view this as yet another cycle, but I do believe it is an important cycle,” he says. For long-time China observers, there have often been predictions of a property market crash and the economy subsequently imploding. This – despite the numerous predictions through various cycles – still has not happened, and Alexander credits China’s policymakers with having the judgement and control to prevent this from occurring.
For international observers looking in, China’s economy can be an emotive topic, says Alexander, and the views of the current situation can be quite polarised. At one extreme there are people with views that are all ‘doom and gloom’ and fear a massive crash because of the size of China’s economy. At the other end of the spectrum are people who are overly enthusiastic about the opportunities of China as the world’s second-largest economy.
The current cycle, Alexander explains, is linked to a broader shift in the nature of China’s economy. The central government is intentionally moving away from the previous economic model where growth was prioritised over other considerations, which is not sustainable, and is now charting a different course. Alexander says that China’s policymakers are trying to wean the economy off its reliance on property, infrastructure and exports and towards consumption. This, Alexander adds, is one of the most consequential economic shifts to take place in China.
As with any economic planning, it is unclear whether it will be successful and there is a certain amount of anxiety that comes with weaning off one thing and relying on another. Looking to the future, one thing that people will be keeping an eye on, says Wang at Hang Seng Bank (China), is what China will choose to rely on instead of property. “A natural question is what will replace property given that it has been the key pillar of China’s growth for 30 years – it has accounted for at least 20% of GDP.” Wang argues that consumption alone will not be enough to replace the reliance on property, and infrastructure also won’t be enough.
One promising sector is the electric vehicle (EV) supply chain. At the moment, Wang estimates that this accounts for 2% to 3% of GDP. If this industry grows at the current rate – which is currently in the double digits – then it could account for at least 15% to 20% of GDP by 2035.
This echoes the view of ANZ’s Group Executive, Institutional, Mark Whelan who said in an interview with CNBC that he is still optimistic – and also cautious – about China’s economy. The property sector and level of government debt are significant issues, but he said he expects them to be resolved within two years. Like Wang, he also looks to the future and sees the potential of China’s focus on sustainability and its EV market. He notes that China is the biggest car exporter in the world (after recently overtaking Japan) and is a leader with its EV batteries – for export as well as domestic use – which will provide opportunities for China’s economy in the future.
For corporate treasurers, and others who are doing business in China, it is one thing to keep an eye on such predictions and monitor the economic updates, but there are other pertinent issues that affect their ability to do business in China. Aside from the economic forecasts – and whether companies are optimistic or pessimistic about China’s recovery – many multinationals view China through the lens of how they can do business there. The realities on the ground, Alexander explains, mean that many foreign executives don’t have an appreciation of how to run a business in China. “When I talk to clients, I explain that China is not nuanced – it is just simply different, and critically so,” says Alexander.
One issue is that organisations are “immensely calcified in terms of their ability to operate in different markets”, says Alexander, which can make operating in China a challenge. He has observed many cases – particularly in financial services – where companies expect to plant their global business processes and platforms into China and run things as they do elsewhere. This kind of approach, however, often does not succeed in China, says Alexander. Multinationals have a way of operating, but they need to know how to adapt on the ground when they do business in China. Often those that will attempt to simply import their global practices and platforms will most likely be unsuccessful – not in the sense of failing completely – but having to change the way they operate.
This issue has come to the fore with multinationals that have taken advantage of a recent rule change that now allows them to be wholly-owned foreign enterprises (WOFE) in China. Previously, if a foreign company wanted to enter the market, its ownership was capped and it would have to enter into a joint venture with a local company. Since the rules came into effect in 2020 a number of financial services companies have taken advantage and established WOFEs. J.P. Morgan, for example, in 2021 received regulatory approval to be the first foreign-owned brokerage in China.
However, for companies that were previously in joint ventures and have now gone it alone, it has not been plain sailing. One issue that such foreign companies have found, comments Alexander, stems from the fact they are now representing a multinational on the ground and are no longer operating as a separate standalone joint venture. The nature of internal accounting at multinational corporations means that various enterprise functions – such as human resources, IT, risk and compliance, which provide services to the Chinese entity – have cost centres that are billed to them. For newly formed wholly-owned foreign companies in China, this means their costs have shot up and local management in China have no control over these internal expenses. “Their cost centres and structures are blowing out,” says Alexander, and this has had an impact on their profit margins now that these entities are wholly owned companies and not independent joint ventures.
Wang comments on other issues that foreign companies are focused on when it comes to China’s economy and future direction. Many are not just concerned with the economy and looking at the opportunities, but also the wider geopolitical situation, says Wang. In particular, there are concerns about the US-China relationship and a continued trade war. Also, the EU-China relationship has come into focus and there are concerns how potential anti-dumping action could impact China’s ability to export to Europe – particularly its EV sector – which it views as a major export market, says Wang.
With issues such as these, many are taking a longer-term view of China beyond the current woes of the property sector and the downgraded growth projections. With signs of a slow recovery on the way, it still remains to be seen whether 79 yuan will still be too expensive for an eyebrow pencil.
