China’s economy is losing momentum. What is happening and why is it important for Australia? | China

China, the second largest economy in the world, is going through a difficult economic phase marked by ongoing anti-Covid measures.

The timing is ill-timed as China heads into November’s 20th National Congress of the Communist Party, which is expected to expand President Xi Jinping’s power.

But the problems go beyond the pandemic and specifically include a deflationary housing bubble. Here we break down China’s economic outlook – and what it means for Australia and other countries.

How is China?

The International Monetary Fund (IMF) last month cut its forecast for China’s GDP growth in 2022 by a quarter to 3.3%. That would be the slowest pace in four decades – excluding the onset of the Covid crisis in 2020 – and below the government’s 5.5% target.

In July, almost every data from retail sales and manufacturing to capital expenditure missed expectations, says Raymond Yeung, ANZ’s chief Greater China economist.

“My biggest concern is employment,” he says, citing urban youth unemployment at 20%, the highest on record.

Lockdowns to enforce China’s zero-Covid policy aren’t just hampering current growth, Yeung said. Future consumption would also fall, while more young people out of work weaken a pillar of China’s real estate market.

Record heat and the worst drought in decades are also contributing to the suffering.

Why it matters to Australia (and beyond).

Australia’s economic fortunes are entangled with China’s, even as we are warned its military threat is the worst in decades.

China is by far Australia’s largest trading partner in both directions, accounting for about a third of all trade. In June alone, Australia’s exports to China (excluding Hong Kong) were over US$16.3 billion, or nearly double the US$8.8 billion worth of imports, according to the Australian Bureau of Statistics. Trading was about 140 times what it was in January 1988 when the series began.

Before Covid, China rivaled New Zealand as the top source of short-term visitors, approaching 1.5 million in 2019. It also catered for nearly 40% of international students, or about twice India’s share.

Australia’s trade with mainland China has varied over time

China dominates global demand for many commodities, consuming 70% of world iron ore exports, much of which is mined from the Pilbara.

But China’s coal and oil imports are falling, says Lauri Myllyvirta, senior analyst at the Center for Research on Energy and Clean Air. “The combination of slowing demand and China’s energy and resource self-sufficiency will be a double whammy for commodity exporters.”

ownership pains rise

Myllyvirta believes China’s July cement and steel output decline should be watched, and agrees with the real estate slump. “Steel rallied but is now falling, reflecting the severe distress in the real estate sector.”

That pain is all the more apparent when developers fail and thousands of mortgage holders refuse to make payments on homes that may never be built. Illustrative images of undated demolitions are also circulating on social media, as are reports of up to 50 million vacant homes.

The collapse of the Chinese real estate market is now so large and extreme that real estate companies are demolishing entire cities with unfinished buildings.

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— Daniel 💙🇺🇦🏳️‍🌈✌🏿✌🏽🌿🌍 (@danielrembrandt) August 20, 2022

Ironically, Beijing triggered part of the downturn to rebalance an overly property-dependent economy. The ensuing gridlock hit developers like Evergrande, which defaulted on part of its $300 billion (US$437 billion) in debt.

S&P Global Ratings last week estimated that 40% of developers are experiencing “financial troubles,” with mortgage boycotts bringing both social stability and economic risk.

“If the strikes spread, they could undermine financial stability, especially if they lead to a sharp drop in home prices,” said Harry Hu, an analyst at S&P.

Loans worth as much as 2.4 trillion yuan ($500 billion) could be affected by the boycotts, according to an S&P report in July.

Real estate bubble with Chinese characteristics

Michael Pettis, a finance professor at Peking University’s Guanghua School of Management, has long warned of the dangers posed by 30 years of rising house prices.

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While China’s economy is about three-quarters the size of either the US or Europe, real estate wealth has grown to twice the size of America and three times the size of Europe. The result inflates both China’s sense of prosperity and a huge misallocation of resources.

Pettis recently noted that developers still need to upfront deliver about 40% of the homes they sold between 2013 and 2020 — in relatively good times.

“Real estate developers have historically depended on rising house prices and rising sales to justify massive leverage and over-development,” he wrote. “But when the bubble began to burst last year, these heavily indebted real estate developers ran into serious liquidity and credit constraints that made it impossible for them to complete their construction projects.”

Workers in Beijing’s central business district. Michael Pettis believes China is in for a prolonged period of low growth. Photo: Wang Zhao/AFP/Getty Images

But while the debt piles in the US in the 1920s and Japan in the 1970s-80s preceded “disasters,” Beijing’s control of banks and much else in the economy portends a slowdown rather than a collapse, Pettis said.

“Domestic financial conditions are such that China is still unlikely to experience a financial crisis or a sharp economic slowdown,” he said. “In my opinion, the country is much more likely to face a very long period of Japan-style low growth.”

He said rate cuts, including on Monday, are unlikely to stimulate much additional borrowing as households and businesses deleverage rather than borrow more.

Big miners remain optimistic even as iron ore prices have fallen a third since April. They are counting on China working its way out of a crisis that has been going on for decades.

“We expect China to emerge as a source of stability for commodity demand over the coming year, with policy support gradually taking hold,” BHP CEO Mike Henry said last week.

“The Problem of Aging”

Similar to Japan, an aging, even shrinking, Chinese population will compound headwinds in the real estate sector and weigh on the broader economy.

China’s population may be on the verge of shrinking if it hasn’t already. That would be the first contraction since the Great Famine of the late 1950s, Unravel reported. That publication cited forecasts by the Shanghai Academy of Social Sciences of a 1.1% annual average decline after 2021.

If this continues, China’s population would more than halve from 1.4 billion to 587 million by 2100.

Pedestrians wearing face masks in central Beijing. Photo: Wang Zhao/AFP/Getty Images

However, Jane Golley, an economics professor at ANU’s Crawford School of Public Policy, is wary of “collapsists” who have regularly predicted China’s impending economic demise.

“‘China’s debt bomb seems poised to explode’ — people have been saying that for years,” Golley said. “Eventually it may well happen, but I don’t think it will happen this year just because of the Covid zero policy.”

Research into China’s scrapped one-child policy revealed a decline in fertility that explains between a third and a quarter of China’s per capita income growth in recent decades.

“If you stop having babies, you reduce youth dependency and you get a surge in the working-age population,” Golley said. “That increases the per capita income.”

She said that raising the retirement age, attracting more women into the labor market and increasing productivity in poor rural areas “can make significant contributions to addressing the aging problem”.

Instead of continuing to achieve annual GDP growth rates of 8%, China is likely to average 2-3% going forward, Golley said. “Anything beyond that makes it the largest economy in the world in our lifetime. And that means it’s a force to be reckoned with.”