What new norm of slower Chinese growth could mean for the global economy

The Chinese economy could face a prolonged period of low growth, a prospect that could have global implications after 45 years of rapid expansion and globalization.

China’s government is stepping up a series of measures aimed at boosting the economy, with leaders on Monday promising to “adjust and optimize policies in a timely manner” for the struggling real estate sector while promoting a strategic goal of stabilizing employment. The Politburo also announced commitments to boost domestic consumer demand and defuse local debt risks.

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China’s second-quarter gross domestic product grew 6.3% year-on-year in the second quarter, Beijing announced on Monday, below market expectations for a 7.3% increase after the world’s second-largest economy emerges from strict Covid-19 lockdown measures.

On a quarterly basis, economic output rose 0.8%, down from a quarterly increase of 2.2% in the first three months of the year. Meanwhile, the youth unemployment rate hit a record high of 21.3% in June. On a slightly more positive note, industrial production growth accelerated to 4.4% YoY in June from 3.5% YoY in May, handily beating expectations.

The ruling Chinese Communist Party has set a lower-than-usual growth target of 5% for 2023, which is particularly modest for a country that has averaged 9% annual GDP growth since the economy opened up in 1978.

In the past few weeks, authorities have announced a series of industry-specific pledges that may be aimed at reassuring private and foreign investors of a more favorable investment climate to come.

However, the measures were mostly broad and lacked some big details, with updates from the Politburo’s quarterly economic affairs meeting showing a dovish tone but no major new announcements.

China’s leadership is “clearly concerned,” Julian Evans-Pritchard, head of China economics at Capital Economics, said in a note on Monday, which described the economic trajectory as “tortuous” and highlighted “many challenges facing the economy.”

These include financial difficulties in key sectors such as domestic demand and real estate, as well as a gloomy external environment. Evans-Pritchard noted that the latest report mentioned “risk” seven times, compared with three in the April report, and that the leadership’s priority appears to be expanding domestic demand.

Evans-Pritchard said: “All in all, the Politburo meeting took a dovish tone and made it clear that the leadership believes that more needs to be done to get the recovery on track. This suggests that some further policy support will be rolled out in the coming months.”

“But the lack of any major announcements or policy details does suggest a lack of urgency, or that policymakers are struggling to come up with appropriate measures to shore up growth. In any case, it’s not particularly reassuring for the near-term outlook.”

triple shock

Rory Green, head of China and Asia research at TS Lombard, said the Chinese economy was still suffering the “triple shock” of Covid-19, prolonged lockdown measures, an ailing property sector and a series of regulatory shifts linked to President Xi Jinping’s vision of “shared prosperity”.

With China less than a year away from reopening after implementing zero-COVID-19 measures, much of the current weakness can still be attributed to the cycle, Green said, but added that without an appropriate policy response, the problems could become entrenched.

“If Beijing doesn’t step in, the cyclical part of the damage from the COVID-19 cycle could align with some of the structural headwinds China faces — particularly in terms of the size of the real estate sector, decoupling from the global economy, demographics — and drive a sharp slowdown in China’s growth,” he told CNBC on Friday.

TS Lombard’s base case sees the Chinese economy stabilizing by late 2023, but the economy is entering a long-term structural slowdown, although a Japan-style “stagflation” scenario is not yet in sight, and GDP growth could approach 4% pa due to these structural headwinds.

While demand for access to China remains crucial for international companies as it remains the world’s largest consumer market, the slowing economy could make it “slightly less attractive” and accelerate a “decoupling” from the West in terms of investment flows and manufacturing, Green said.

For the global economy, however, the most immediate spillover effects of China’s slowdown are likely to be in the commodity and industrial cycles, as China reconfigures the economy to be less dependent on the real estate sector that “absorbs and drives commodity prices”.

“Those days are gone. There will still be a lot of investment in China, but it will be more advanced manufacturing and technology hardware, like electric vehicles, solar panels, robotics, semiconductors, these types of things,” Green said.

“With the real estate drivers – and iron ore from Brazil and/or Australia, machinery from Germany or appliances from around the world – gone, China will be significantly less important in the global industrial cycle.”

second order effects

China’s big push into electric vehicles, a sign that the economy is shifting away from real estate to more advanced manufacturing, has led to the country’s surpassed japan earlier this year as the world’s largest car exporter.

“The transformation of Beijing and Berlin from complementary economies (where Beijing and Berlin benefited each other) to now rivals is another major consequence of the structural slowdown,” Green said.

In addition to the immediate loss of demand for commodities, China’s response to changes in its economic situation will also have “secondary effects” on the global economy, he noted.

“China is still making a lot of stuff, but they can’t consume it all domestically. A lot of stuff they’re making now is much higher quality, and that’s going to continue, especially with less money going into real estate and trillions of yuan going into these advanced technologies,” Green said.

“So the second order effect is not just less demand for iron ore, but more global competition for a range of advanced manufactured goods.”

While it remains unclear how Chinese households, the private sector and state-owned enterprises will respond to the shift from a model driven by real estate and investment to one driven by advanced manufacturing, Green said China was at a “critical point”.

“The political economy is changing, partly on purpose, partly because the real estate industry is effectively dead, or even if it isn’t dead, so they have to change and a new model of development is emerging,” he said.

“It won’t just be a slowed-down version of the pre-COVID-19 Chinese economy. It’s going to be a new version of the Chinese economy, also at a slower pace, but it will have new drivers and new idiosyncrasies.”