Has China peak pessimism been reached and can China be replaced?

October 6, 2023

Asian worker working in the steel market.

Following my trip to China in May 2023 and my recent commentary from June, I believe it is important to continue to share our thoughts on China, especially in light of recent disappointing economic developments and the new policy measures aimed at addressing its slowing economy.

Have we reached peak pessimism about China?

The real estate sector, along with its related industries, accounts for 20% to 30% of China’s GDP and has failed to rebound as expected. From January to July, real estate investment fell 8.5% year-on-year. Residential building areas deceased by 7.1% and total new construction areas declined by a quarter according to the National Bureau of Statistics.

China’s government has announced a slew of measures in the past few months to stimulate the sector, including:

  • Fiscal incentives: The Ministry of Finance on Aug. 18 extended personal income tax rebates for households upgrading their apartment until the end of 2025.
  • Mortgage easing: Banks no longer exclude those who have a repaid a mortgage from qualifying as first-time buyers if they don’t currently own a property. Big cities including Guangzhou and Shenzhen adopted this policy on Aug. 30.
  • Home-loan cuts: Starting Sept. 25, first-time homebuyers can renegotiate their mortgage interest rates, as announced by the central bank on Aug. 31.
  • Downpayment reductions: On Aug. 31, Beijing lowered the minimum downpayment ratio across the country to 20% for first-time homebuyers and 30% for second purchases.
  • Urban renewal: The State Council announced redevelopment support for older villages within mega cities. Metropolises including Shanghai and Guangzhou are following up.
  • Other measures: These include a nationwide cap on real estate commissions, allowing private equity funds to raise capital for residential property developments, pledging ¥200 billion (CDN$28 billion) in special loans to complete stalled housing projects and extending some of the 16-point plan to address liquidity issues in the sector.

We should soon find out if these measures prove adequate. The Mid-Autumn Festival from Sept. 29-30 followed by a week-long holiday from Oct. 1-6 for National Day is traditionally the busiest period of the year for real estate sales. But what if the bubble continues to deflate? Could it lead to a collapse contained within China or a long stagnation like Japan experienced? Or to something more globally damaging similar to the Great Financial Crisis of 2008?

Will China crash?

Contrary to these fears, we do not see a huge financial crisis in China. The country is a major creditor, most of its debts are in its own currency and the government controls all of the key banks.

The current risk is the elevated savings rate, which could weaken demand.

Is China’s economic situation a repeat of Japan in the early 90s?

China today and Japan 30 years ago share many similarities: high debt levels, an aging population and a property bubble pop after years of growth. But China’s asset bubbles are comparatively smaller. And, in some cases, one could argue that the US also is in bubble territory. The following table is quite telling:

China US Japan
(1990 peak)
Property value/GDP 260% 180% 560%
Stock market/GDP 65% 151% 142%
Urbanization rate 65% 83% 77%
Debt/GDP 95% 122% 62%

Source: World Bank and IMF.

Is it all bad? Can China bounce back?

China’s economy was supposed to drive a third of global economic growth this year. Its recent slowdown is sounding alarm bells across the world. According to an International Monetary Fund analysis, when China’s growth rate rises by 1 percentage point, global expansion is boosted by about 0.3 percentage points. Asian economies, along with African countries have been most affected by diminished trade. For example, Japan reported its first drop in exports in more than two years in July after China cut back on purchases of cars and semiconductors. Central bankers from South Korea and Thailand last week cited China’s weak recovery as a reason for downgrading their growth forecasts. The value of Chinese imports has fallen for nine of the last 10 months as demand retreats from the record highs set during the pandemic. The value of shipments from Africa, Asia and North America were all lower in July than a year ago. But is the situation as dire as appears? Some indicators seem to tell a different story.

The price of oil is approaching $100. According to a September report by OPEC, global crude oil demand is expected to reach a record 102.06 million barrels per day in 2023, up 2% from 2022. Demand in China, the world’s second-largest crude oil consumer, is projected to grow by 6% to 15.82 million barrels, an upward revision of 50,000 barrels from August. Official customs data shows that China’s crude oil imports in August reached 52.8 million tons, up 21% from the previous month. This translates to a 31% year-on-year increase and a 25% rise over pre-pandemic levels in August 2019. With overseas travel from China still not back to pre-pandemic levels, further growth in demand for crude oil and petroleum products could be expected as noted by Dominic Schnider, UBS’s head of commodities and Asia-Pacific currency markets.

In terms of metals, China’s refined copper consumption was the second-strongest year to date in August, a month when demand would typically weaken due to hot weather. This was reflected in a 36.6% increase month over month in China’s copper concentrate imports in August.

China’s aluminium imports jumped 38.9% in August from a year earlier, customs data shows.  Imports of bauxite, a key raw material for aluminium, totaled 11.63 million tons last month, up 9% from the year prior. Bauxite imports in the first eight months of the year, at 96.62 million metric tons, were up 11.8% from a year earlier.

In our last commentary on China, we highlighted how it is trying to transition its economy away from real estate, infrastructure and exports to a more sustainable model led by domestic consumption, services and tourism. There is a lot of potential to unleash tremendous growth if Chinese consumers decide to increase their spending.

A study by the Australian Strategic Institute earlier this year showed that China leads in 37 of 44 tech fields, ranging from AI to robotics. China graduates 1.4 million engineers each year and leads the world in patent applications.

Source: World Economic Forum.

Technology fields and leading countries

Source: Australian Strategic Institute.

So, while there is a case for optimism, what if relations between China and its trading partners continue to deteriorate. What if trade barriers go up?

Who could replace China as a global economic engine?

Policymakers in the West may view a China slump as a geopolitical respite, but it raises a significant question: what are the global repercussions if China’s economy were to permanently stagnate?

According to World Bank data, China GDP grew by 263% between 2008 and 2021, while global growth was only 30%. China accounted for more than 40% of global growth during that period. Although some experts have pointed to India as a possible successor, it’s not a given. India’s manufacturing sector has contracted in recent years and private investment accounts for a smaller share of GDP than it did a decade ago.

Could this signal the end of global economic growth?

Global growth by period

1962-1973 5.4%
1977-1988 3.3%
1991-2000 3.0%
2009-2023 65%

Source: Capital Economics

We do not think the China growth story is over and believe the China pessimism is too extreme.

Global Alpha Capital Management Ltd.
October 6th, 2023