China’s slowing economy needs a stimulus it might not get

It all started with a defiant trade war that the then US President Donald Trump started with China in 2018. He imposed tariffs on imports from China, across various sectors and industries that dislocated supply chains across the world. The trade war has now morphed into a full-blooded cold war. 

The pandemic aggravated the pace of the ‘decoupling’ of China’s economy with the US. Many American companies, most notably Apple, decided to move manfuacturing capacity into other Asian countries, including India. Considering India’s growing middle class and demographic sweetspot in terms of potential consumption growth, the only roadblock was India’s choked infrastructure. 

With the emphasis on infrastructure by the Centre, and its production-linked incentive schemes, India has managed to take a sliver out of the China+1 strategy that many global companies are now employing. Initially, it was thought that the strategy was a reaction to the supply chain mess caused by harsh lockdowns in China during the Covid-19 pandemic. But the previous bout of trade wars under Trump is also one of the causes.  

Trade war turns into a cold war

President Biden hasn’t eased up on the intensity of tariffs and has also imposed sanctions on Chinese entities, which include export controls on industries like manufacturing of semiconductor chips, electronics, aerospace, among others. Although some of these sanctions are a result of Chinese companies supplying inputs to Russia and Iran, the trade war is now a full-fledged economic war.

China on its part tried to escape some of the impact of this by sewing up deals with many countries globally to trade in its own currency. Any success on this front will show up only in the longer term, but in the short term, the dislocation to its companies sourcing capabilities because of sanctions is also aggravating its economic slowdown.

China’s predicament is the total opposite of the economic trends in the US, which is struggling to anchor inflation to its 2% target. Despite the US Fed’s funds rate being at a two-decade high, economic growth in the US clocked 2.4% in the June quarter. China’s economy seems to be heading towards deflation. Some even suggest this is a Japan-style slowdown in China’s economy.

Echoes of a past crisis

China’s current crisis stems from its past efforts to make its economy more competitive globally. The shock devaluation of the yuan in 2015 led to a surge in outflows from the country amounting to $500 billion over the next two years. Chinese authorities had to employ various measures to stem this exodus through capital controls.

The devaluation was to ensure China’s export-focused economy remained competitive globally. But in 2018, the trade war made sure such calculations came to nought. With the pandemic, the global economy was badly bruised, which led to many countries employing fiscal and monetary stimuli to resuscitate their economies. China was among them.

The uniqueness of China is that it has more than 90% home ownership, and the real estate sector, including ancillary businesses, contribute 20% to the country’s economy. In 2021, there was a big blowup of Evergrande Group, the second-largest real estate developer in China. This laid bare the excessive leverage sloshing around in China’s economy. At the end of the June quarter, China’s overall debt-to-GDP ratio stands at 281.5%, which is the highest level ever. Its household debt is also at its highest level.                 

China’s retail inflation was at zero in June 2023, while inflation at factory gates fell 5.4% during the month. The country’s fiscal and monetary authorities are planning targeted stimulus to boost demand among consumers and businesses. But with balance sheets among both consumers and businesses, including local government, is impeding any durable economic recovery.

One may wonder why a 6.5% economic growth in the quarter ended June 2023 is alarming. Well, for one the market expectation was 7.3% because of the low base in the June 2023 quarter which grew just 0.4%.

Hawkish global central banks play party pooper

Another factor that is souring the pitch for China is the drastic actions taken by central banks globally to combat runaway consumer price inflation. This is meant to curb demand in their home countries. But the impact of this is also showing up in China’s slowing exports in 2023.

In a way, major economies, in their effort to combat inflation, are tamping down on demand for Chinese exports. This in turn is leading to slower economic growth in China, which is being reflected in producer prices (prices at factory gates) indicating deflationary trends.

Without the support of China’s real estate sector, and large-scale stimulus not being rolled out, China’s economy is caught in a funk that it desperately wants to get out of.

Why should you care

The surge in the Indian stock markets since April 2023 was partly fueled by fund managers and portfolio managers globally looking for better avenues because of a slowing Chinese economy. That is why you are seeing valuation multiples in many Indian stocks trading beyond historical averages. In the past, domestic flows into markets, led by nearly $2 billion inflows through mutual fund SIPs.

With China’s economy wobbling, the flow of foreign money into Indian markets might sustain. There couldn’t be a better time to reorient the Indian economy to become a factory to the world, while also serving the domestic market. The time to see action on the ground rapidly and durably is now. This might be the opportunity to finally unleash India’s demographic dividend.

Hopefully, there aren’t many slips between the cup and the lip.