The end of China’s challenging chapter?

Well-documented challenges

The Chinese economy, which grew at an average annual rate of some nine
percent in the three decades to 2020, is now growing much more slowly.
This should not be entirely surprising, as the economy is more mature and
much larger than it was years ago, but it nevertheless faces some
challenges, including:

• Shrinking and ageing population: China’s population has
  been declining since it peaked at 1.426 billion people in 2020, with a
  median age of 39.6 years, compared to 23.7 years in 1990.
• Housing market woes: Prior excesses have reduced demand
  for new properties and caused builders’ bankruptcies. Consequently, home
  sales and prices have declined. The housing market’s troubles have
  impacted consumption and investor sentiment, as the property sector
  accounted for up to 25 percent of GDP at its 2022 peak, with significant
  household wealth tied to it.
• Favouritism for the state over the private sector: The
  authorities have in the past prioritized state-owned enterprises over
  the private sector, viewing them as vital to maintaining economic
  stability and ensuring strategic control and sovereignty. This
  preference has often resulted in private businesses facing more
  stringent regulations.

Concerns – Legitimate, but overblown

Concerns regarding China’s prospects are thus legitimate, but RBC Global
Asset Management, Inc. Chief Economist Eric Lascelles has long believed
that the struggles of the Chinese economy have been exaggerated.

He points out that while the housing and consumption of goods and services
are weak, traditional sources of Chinese strength, such as exports and
industrial production, remain relatively strong.

GDP growth for the first three quarters of 2024 reached 4.8 percent
relative to the same period a year earlier.

Exports and industrial production remain strong

Monthly economic indicators for China

The column chart shows the progress of China’s exports, industrial
production, retail sales, and property sales from 2019 to 2024, with
2019 levels indexed to 100. While property sales are much below 2019
levels, all three other variables are above. Exports and industrial
production in particular are markedly higher than when the country
exited its most stringent COVID-19 lockdown measures in December 2022.

• Exports

• Industrial value added

• Retail sales

• Property sales

As of September 2024. Average of 2019 levels indexed to 100.

Source – RBC Global Asset Management, Haver Analytics

Stimulus!

Yet, local governments are in a precarious position, banks may need
further support, and the property sector is still weak. After implementing
a number of targeted measures to stimulate certain areas of the economy
over the past few years, the country’s policymakers unveiled significant
initiatives in late September 2024. They also hinted at a coordinated
effort to enhance economic growth through both monetary and fiscal
policies. Key monetary measures include:

• An additional 50 basis points (bps) cut to 6.6 percent to the average
  Required Reserve Ratio, the monetary policy tool used by the People’s
  Bank of China to control the money supply and manage liquidity in the
  banking system. The authorities prepared the ground for another cut by
  year-end;
• A range of cuts to related interest rates, including a 50 bps reduction
  in mortgage rates;
• A reduction to 15 percent from 25 percent in the minimum downpayment on
  second properties; and
• A total of 800 billion renminbi (US$112 billion) in liquidity backing to
  support stock market purchases by major Chinese financial institutions
  and companies.

Meanwhile, the Ministry of Finance announced that fiscal spending would
increase before year-end and next year, though details have been lacking.
Delays may indicate that reaching a consensus on the amount of borrowing
required and how it should be spent has been difficult. Details are widely
expected when the National People’s Congress Standing Committee, China’s
legislature, convenes November 4–8.

Possible measures include support for local governments burdened by
significant debt, a move that could also aid banks that extended loans to
these local entities.

Steps to bolster demand are also likely, potentially including an
expansion of the national safety net, according to Lascelles. Chinese
households tend to save rather than spend, with the country’s national
savings rate exceeding twice that of the U.S. Gross national savings as a
percentage of GDP stands at 43 percent compared to 17 percent in the
United States.

Caixin Global, a media group, reports that, overall, China’s central
government may borrow six trillion renminbi (US$842 billion), or the
equivalent of a substantial five percent of GDP, though a more modest
amount may be announced. By comparison, to mitigate the impact of the
global financial crisis in 2008, China launched a stimulus program of more
than US$575 billion, which represented then 12.5 percent of GDP.

Overall, Lascelles explains that expectations need to be managed carefully
given that the Chinese economy is unlikely to ever return to its prior
glory days of six percent-plus growth. He believes that given the
demographic challenge and China’s advanced stage of development, a gradual
deceleration to annual growth of three percent or four percent is the most
likely scenario. Furthermore, economic development is no longer the sole
focus for the authorities, as they now also place a high priority on
national security, food security, energy security, and tech
self-sufficiency.

Still the main engine for the world economy

A three percent growth rate would be enough to keep China as a global
power, in his view, and to allow it to continue advancing down the same
road taken by Japan and South Korea toward developed-world status.

Moreover, despite a more muted growth, the International Monetary Fund
expects China to remain the largest single contributor to global growth.
It estimates China will generate almost 22 percent of world economy growth
from 2024 to 2029, roughly twice as much as the United States and by far
the largest of any country.

China to remain the single largest contributor to global growth

Contributions to world economic growth 2024–2029, IMF forecast

The pie chart shows the International Monetary Fund’s projections for national contributions to world economic growth for 2024 to 2029. China is expected to contribute 21.7 percent of global growth and be the largest single contributor, followed by India with 14.8 percent and the U.S. with 11.6 percent. Other notable contributors are: Indonesia, 3.50%; Russia, 2.10%; Brazil, 2.00%; Türkiye, 1.90%; Egypt, 1.70%; Germany, 1.70%; Japan, 1.70%; Bangladesh, 1.60%; United Kingdom, 1.40%; Vietnam, 1.40%; France, 1.40%; Saudi Arabia, 1.30%; Mexico, 1.30%; Korea, 1.30%; Philippines, 1.20%. The rest of the world’s nations are expected to contribute less than 1% each, totaling 26.4%.

“Rest of world” includes countries contributing less than 1.2% to
global growth.

Source – RBC Wealth Management, IMF World Economic Outlook October
2024

Portfolio implications

The Shanghai Stock Exchange Composite Index, which had been out of favour
by languishing at low valuations, surged more than 25 percent on the
announcement of new monetary measures, though it has since pulled back
slightly. Substantial forthcoming fiscal announcements could help the
rally regain some vigour, though conversely, modest fiscal measures could
disappoint markets.

We suggest maintaining a Market Weight position on Asia Pacific equities
as part of a global portfolio. Most non-domestic investors would have
exposure to China through emerging market funds where China represents
close to 25 percent of the index. For investors who can invest directly,
we prefer quality companies with a robust balance sheet and steady cash
flows, such as selected internet names, and high-dividend stocks with high
earnings and shareholder returns visibility, which could benefit from the
aforementioned central bank’s liquidity support for the stock market.

With contributions from Leo Shao.