The accumulation of deteriorating economic indicators seems to have prompted the Chinese central bank to cut interest rates by 10 basis points. As a result, despite the ongoing process of economic growth, we are encountering a significant slowdown. This, in turn, is leading Chinese 10-year bond yields to fall from 3 to 2.55% since the beginning of the year. It is worth considering what negative factors are contributing to the current state and what we can expect in the future?
Declining demographics are one of the main factors in the slowdown
One of the main reasons for the economic slowdown in China is the drastically falling demographics. The accumulating problems are the result of the previous one-child policy, which the Chinese government introduced in 1979. The consequence is that the number of employed people has fallen almost to the levels of before the beginning of this century. Since 1990, the birth rate has not exceeded the level of 2.1, which is considered the minimum for demographic development. It currently stands at around 1.1. In this respect, it appears that China resembles a power in decline rather than one that is gaining ground.
Source: Tradingeconomics
Declining GDP is not the only problem
While it is hard to consider economic growth of 6.3% y/y as a recession, it is worse than the expected 7.3% y/y. We can also see warning signs in the macroeconomic data.
OPEC analysts forecast a decline in the rate of consumption of oil and oil products in the range of 6-10% to 3-5% from Q3 this year. Oil consumption is particularly important in the context of the development of the Chinese economy, which is the second largest consumer of oil in the world, just after the United States. China's share of global demand is as high as 15.7%. The volume of oil consumption by the Middle Kingdom appears to be a key indicator for assessing the development of this economy. Analysing China's economy in this way, it is indeed possible to conclude that economic growth is set to slow down. Nevertheless, no signs of recession have been observed here so far. Therefore, it seems that we should not see a significant drop in oil prices in the long term.
Source: OPEC
Decline in exports due to West's breathlessness
Investors are becoming increasingly concerned about bad markets following the release of the latest data on Chinese exports, which fell by 14.5% year-on-year, the biggest drop since the outbreak of the pandemic crisis. The main reason for this decline in goods exports appears to be a reduction in demand from Western countries, especially the US, which is the recipient of as much as 17% of all Chinese exports.
Source: Tradingeconomics
Has China lost its formerly attractive investment status?
After the 2008 crisis, the rate of investment in fixed assets of Chinese enterprises has steadily declined - from around 20% to the current 3.4% in annual terms. The main area responsible for this decline in growth is investment in the real estate sector. Here, there was a decline of 8.5% on an annualised basis. This seems to be related to an excessive focus on this sector in the economy, as highlighted by the recent declaration of bankruptcy of one of the largest developers, the Evergrande Group. Such a situation could indicate a repeat of the property crisis, similar to the one in 2008, although this is not yet visible in property prices in the country.
Source: Tradingeconomics
Deflation. Yes, deflation in China....
What may come as more of a surprise to Western investors is the current decline in the prices of goods and services in China. This phenomenon is evident, among others, in the CPI consumer inflation index, which falls by 0.3% on an annualised basis, and in PPI producer inflation, which fell by 4.4%. Deeper analysis reveals that the main factors behind this fall in prices are reduced transport and raw material costs. It appears that these factors were among the main determinants of the Chinese central bank's decision to cut interest rates. The question may arise as to why Asian economies such as China and Japan have not had to deal with the global inflation we have seen in Western countries? It seems to be because the growth of the money supply (measured, among other things, by the M3 aggregate) was in no way different from the pre-pandemic situation, unlike in Western economies.
Source: Tradingeconomics
Deflation has historically often been the predecessor of economic downturns or recessions. An example is Japan, which has long suffered from deflation and its negative effects, including reduced demand and investment.
Despite concerns, the Chinese economy appears to be resilient and the authorities are able to intervene. The case of Japan shows that avoiding prolonged deflation may require appropriate policy action and economic stimulation.
Source: Tradingeconomics
Grzegorz Dróżdż, CAI MPW, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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