“A lot has changed”: China’s economic woes understated says Capital Economics

The reopening of China’s economy after extraordinary COVID-19 containment measures which lasted over two years was a much-hyped market event. For a short time, investors – particlalury China bulls – felt vindicated. A bounce in Chinese stocks saw popular names such as JD.com (NASDAQ: JD), Tencent (HKG: 0700) and Alibaba (NYSE: BABA) surging up to 100% in late 2022.

But the hype now seems to have been short-lived. Most of the immediate post-lockdown gainers, have since lost considerable ground.

For example, JD.com an e-commerce giant profoundly exposed to Chinese domestic consumption has fallen around 50% since its January 2023 high, recently notching a new 52-week low.

So in a nation where (unlike the US) interest rates aren’t rising and inflation isn’t an issue, why haven’t Chinese stocks rebounded like many expected?

In a new report by Capital Economics, the respected adviser to leading hedge funds identified four key economic challenges it says it first identified over five years ago.

  1. Demographic pressures are causing the growth of China’s working age population to slow and contract.
  2. The output per worker (or productivity) in China is increasing at a much slower pace as China reaches the limits of its growth model.
  3. High rates of domestic savings have resulted in household consumption accounting for a relatively small share of GDP and requiring China to rely on other sources of demand to sustain growth – mainly investment and exports.
  4. The sheer size of China’s economy means it’s becoming difficult to sustain rapid growth in export demand – 15% of global exports now come from China and new markets are hard to find, while China’s dominance across the production of many goods was increasingly likely to elicit pushback from trading partners.

“All of this meant that a new wave of reform was needed to avoid a medium-term growth slowdown, including reforms to direct a greater share of income to households, and thus make consumer spending a more important source of demand,” said Capital Economics’ chief economist, Neil Shearing.

But that hasn’t happened.

Existing Chinese economic headwinds now worse

Shearing points out the aforementioned headwinds that have cast a shadow over the Chinese economy for much of the past decade have now become headier.

“A lot has changed in the past five years, but in each of the areas we flagged in our initial report, the constraints on growth have only become more pronounced,” he said.

“The demographic outlook, for example, has deteriorated faster than we had anticipated. Three years ago the UN thought that China’s population would peak in 2032. Now it thinks that the population peaked last year – a decade earlier than expected.

China economy

“Likewise, while property investment continued to grow at a solid pace in 2018-19, the volume of new floor space peaked in 2021 and has since fallen sharply. The crisis at China Evergrande became emblematic of broader excesses in property construction and development. A similar reckoning now looms in infrastructure and its funding via local government financing vehicles.”

And he adds, increasing geopolitical tensions have created even more uncertainty.

“The trade wars that started during the Trump administration have morphed into a broader fragmentation of the US-China relationship. This will touch everything from supply chains to cross-border financial flows.”

According the Shearing, these trends will have huge consequences for what the global economy looks like in the decades ahead. He also tips they will challenge the widespread assumption that China will inevitably overtake the US as the world’s largest economy.