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In the year of the dragon, which, in terms of the Chinese zodiac cycle, symbolises strength, good fortune and power, the 2024 economic growth and inflation targets announced by China’s National People’s Congress early in March this year seem ambitious and unrealistic. This is if Beijing does not announce further stimulus – targeted at the appropriate areas of the economy – soon.
On the back of last year’s 5.2% real growth rate, which was bolstered by the low base of 2022, and an overall average annual consumer inflation rate of less than 0.5% in 2023, China announced a real economic growth target of around 5% and a headline consumer inflation target of around 3% for 2024. This is against a backdrop of an economy that was largely in deflation (falling prices) for the majority of last year and still is mired by a property sector that is in a deep recession, a manufacturing sector that sits with severe overcapacity, local governments that are hampered by high debt levels, and by a Chinese consumer that is reluctant to spend.
If one were to assess the outlook for the Chinese economy, one could break it down into its core components, using the following equation:
Chinese economic activity = household consumption expenditure + fixed asset investment spending + government spending + (exports – imports)
To expand on these variables:
Household consumption
In China, household consumption as a percentage of the size of the economy averages around 38% to 40%, compared with roughly 67% in the USA, for example. The outlook for Chinese household consumption spending in 2024 is going to be muted by unemployment rates, which although lower than during the peak of 2022, are still relatively high, and by depressed consumer confidence, due to the severe challenges in the property market and a flailing domestic stock market which has fallen precipitously over the past three years. We expect a modest recovery in household spending in 2024, which could be boosted if authorities were to implement specific support measures that target consumption. However, at this stage, this is absent and seems unlikely over the short to medium term.
Government spending
Government spending in China typically ranges between 15% and 20% of the size of the economy, which makes it one of the other core drivers of economic activity. Unique to China, the central government typically plays a limited spending role, while the action takes place at the local government level. And herein lies the rub: a big portion of the income from local governments comes from land sales. With the property market in deep distress, land-sale revenues have dried up, which is seriously hampering the abilities of local governments to spend, invest, and thereby boost economic activity. Beijing is attempting to prevent a spiralling local government debt crisis. Part of their current solution to this growing problem has been the issuance of special refinancing bonds through which local authorities can roll over the debt into lower-interest bonds which will then naturally reduce the interest payment burdens of local governments. Beijing has also approved some debt swaps and although positive, this seems insufficient to address this issue. In our view, local government finances are likely to be depressed for much of this year, hence placing the onus on the central government to boost spending and support economic activity.
At the central government level, debt is still largely contained, which does leave room for central government fiscal expansion. In December last year, China’s central bank, the People’s Bank of China, injected a significant amount of money via their so-called Pledged Supplementary Lending (PSL) programme for on-lending via state banks to further provide credit supply for their Three Major Projects programme to support urban village renovation, social housing and selected infrastructure projects that have a dual purpose, for example, buildings which could quickly be converted to hospitals, when/if needed. PSL funding operations were one of the core ways in which authorities helped stabilise the property sector during 2015 when they spent around CN¥3.5 trillion over four years, which equated to a roughly cumulative 5.5% of the size of the economy between 2015 and 2018. This is, therefore, an important source of potential further stimulus, which needs to be closely monitored for its likely progressively positive impact on economic growth going forward.
Fixed asset investment
From a fixed asset investment perspective, China stands out with a contribution of more than 40% to the size of the economy, versus around 15% to 17% in the USA. Of China’s fixed asset investment, manufacturing fixed asset investment is by far the largest, followed by infrastructure investment and real estate. Manufacturing and infrastructure fixed-asset-investment spending have seen some explicit government support in recent years and are expected to continue to show decent growth going forward. However, it is the beleaguered property sector in China that remains one of its core Achilles heels.
Property Sector
If one includes the upstream and downstream industries related to the property sector in China, then the domestic property sector can easily constitute more than 20% of the total Chinese economy. Residential property ownership is abnormally high in China, and property constitutes roughly 60% of household wealth; hence, the health (or not) of the property market directly influences Chinese consumers’ pockets, confidence, and spending.
To a certain extent, China’s current property woes are self-inflicted. Back in August 2020, Beijing introduced its Three Red Lines financial regulatory guidelines, which capped debt-to-cash, debt-to-assets and debt-to-equity ratios for Chinese property developer borrowing. This policy was implemented in order to address the sky-high debt levels of many companies in this sector. As a result, many developers became cash-strapped and were unable to finish property projects, which prompted mortgage boycotts by some buyers, defaults on property developer loans and even bankruptcy of some of the big players in this sector, including China Evergrande Group (which was one of the top three property developers by sales).
China’s property sector is likely to take a very long time to heal as it not only grapples with confidence and developer funding issues in this current cycle but also must deal with the longer-term structural challenges regarding worsening demographics and slower urbanisation, amongst other factors. However, from a rate of change perspective, we are likely to see a smaller negative contribution from China’s property sector to overall economic activity this year than in either 2022 or 2023 when floor space sold and started was deeply negative. Even if China’s property sector were only to stabilise this year, and not grow, the impact on overall economic growth would be much improved versus the previous two years.
Exports less Imports = Net exports
Despite China having normalised from the peak of the work-from-home and personal-protection-goods demand cycle during the Covid years, and it having to deal with high-and-rising geo-political tension with the US in particular, China continues to be a major world manufacturer and global exporter, with a current market share of about 15% of global exports. On a stand-alone basis, Chinese exports easily constitute about 20% of the size of China’s economy in any given year, while imports typically hover between 15% and 17% of the size of the economy.
What matters from an economic growth perspective is net exports (exports minus imports). In China’s case, net exports are typically a small positive contributor to growth as China tends to run trade surpluses with the rest of the world (China exports more to other countries than it imports from them).
With an expected slowdown in global growth this year, and with fairly depressed Chinese local demand, we don’t expect net exports to be a major contributor to growth this year.
With an expected slowdown in global growth this year, and with fairly depressed Chinese local demand, we don’t expect net exports to be a major contributor to growth this year.
Our China-2024 growth and investment outlook
Overall, and given the current stimulus in the economic system, we project 4.5% real economic growth for China in 2024, 4.25% in 2025, and 4% in 2026. These forecasts incorporate still significant economic challenges including weak consumption growth, unsustainably high debt levels and a property market which, at best, stabilises this year.
For China to reach its rather ambitious 5% growth target in 2024, it would need more than just good fortunes related to the Year of the Dragon. It would indeed need harmonised, flexible, and targeted additional fiscal and monetary stimulus and a more supportive regulatory environment to improve confidence, which encourages spending and investment. Without these, China’s growth target will remain ambitious.
Overall, from an investment perspective, we acknowledge that the Chinese equity markets are undervalued following a period of severe underperformance, which subsequently pushed up its expected returns (see graph below). Often, from such deeply depressed valuation levels, technical rallies are possible off that low base. This is what we have witnessed in recent weeks when Chinese equity has bounced back from multi-year lows.
However, despite this recent rally, China still has a lot of lost ground to cover within the emerging market (EM) universe. Whether it achieves outperformance in the emerging market equity space going forward depends to a large extent on Beijing, which, at this stage, seems unwilling to embark on bazooka-like stimulus. As such, and for now, we maintain n on-benchmark exposure to China in our asset allocation.