What is happening with the Chinese economy? Explained.
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Background:
In the annals of modern history, few narratives rival the phoenix-like rise of the Chinese economy, ascending from the ashes of an agrarian past to a towering economic titan. In recent history, China's economic growth has been extraordinary, going from a mainly farming-based economy to a huge and dominant industrial powerhouse. It's like a rocketing rise, challenging the existing global power balance. China's economy is often seen as a symbol of strength, growth, and immense power on the world stage. However, things can't keep going perfectly forever. Underneath the apparent prosperity, many complicated problems and dangers could put out the once-strong economic growth. Lately, there's been talk about an unexpected and never-before-seen change happening in China's economy. It's like the dragon, which was once powerful, is now caught in a very serious situation, facing a potential major economic crisis that might change how the world's finances work. The question that remains a mystery, how serious is China’s economic meltdown.
What is happening in China?
China's economy is facing several challenges, including a collapsing real estate market, a crackdown on the tech sector, a zero-Covid strategy that has disrupted economic activity, and a demographic crisis that is leading to a shrinking workforce and a growing population of retirees. These factors are creating a ‘balance-sheet recession’ where businesses and individuals are too focused on paying down debt rather than spending money. This is leading to deflation in China while the rest of the world is trying to cope with high inflation.
One of the biggest challenges facing China is the collapse of its real estate market. The market has been driven by excessive debt and government regulation. In recent years, the government has taken steps to cool down the market, such as restricting lending and imposing new taxes on property purchases. These measures have hurt the market, leading to a decline in prices and sales. The real estate market is a major driver of the Chinese economy, accounting for nearly 30% of GDP. Thus, the collapse of the market is having a ripple effect throughout the economy, hurting businesses and consumers.
Another challenge facing China is the crackdown on its tech sector. The government has cracked down on tech companies in recent years, citing concerns about antitrust violations and data security. The crackdown has hurt innovation and investment in the tech sector. The tech sector is a major source of growth for the Chinese economy. The crackdown is hurting economic growth and is also leading to job losses. The zero-Covid strategy is also harming the Chinese economy. The strategy has led to lockdowns and other disruptions to economic activity. The lockdowns have hurt businesses and consumers, and have also led to supply chain disruptions. The zero-Covid strategy has been successful in containing the spread of Covid-19 in China. However, it has come at a high economic cost.
The demographic crisis is another major challenge facing China. The country's population is ageing rapidly, and the workforce is shrinking. This is due to China's one-child policy, which was in place for decades. The demographic crisis is harming economic growth and is also leading to a shortage of workers in some sectors. It remains to be seen whether the Chinese government will be successful in overcoming these challenges. However, the country's future economic growth and prosperity will depend on its ability to do so.
Heavy reliance on exports
China is the world's largest exporter of goods, with exports accounting for about 20% of its GDP. In 2021, China's exports of goods totaled USD 3.36 trillion with its top markets being the United States, Hong Kong, Japan, South Korea, and Germany. China exports a wide range of goods, including electronics, machinery, textiles, and toys. These exports provide jobs for millions of Chinese workers and generate revenue for Chinese businesses, which helps to boost the economy. These exports also keep the Chinese currency, the yuan, stable. However, its heavy reliance on exports is affecting it in several ways. Firstly, the Chinese economy has become vulnerable due to downturns in the global economy. When other countries are doing poorly, they buy less from China, which hurts Chinese exporters. This is what is happening now, as the global economy is slowing down due to the war in Ukraine and other factors. The war in Ukraine has also harmed the global economy, and it has also led to higher energy prices, which has hurt Chinese businesses. Secondly, China's reliance on exports makes it more exposed to trade wars and other geopolitical tensions. The US-China rivalry in the Indo-Pacific region and the trade war between the two has hurt both economies, and it has also made it more difficult for China to export goods to the US. The US is trying to contain China's rise in the region, and this is leading to increased tensions between the two countries.? Thirdly, China is finding it difficult to transition to a more sustainable economy. China can reduce its reliance on exports and boost domestic consumption, however, that doesn’t seem to be happening in any near time.
Declining offshore Yuan and GDP forecasts
The economic situation in China has led to a depreciation of its offshore yuan, which is expected to reach an all-time low of 7.6 against the US dollar by the end of the year, as per a Bloomberg survey. The yuan has already depreciated by 5% since January, making it one of the worst-performing currencies in Asia. The offshore yuan is utilized by investors and businesses outside of mainland China and operates with fewer restrictions compared to its onshore counterpart, where the People's Bank of China determines a narrow trading rate each day. The offshore market behaves more like a free-floating exchange. In terms of GDP forecast, China's economic slowdown is anticipated to moderate further, likely causing a miss on the growth target of 5.5% for this year. This situation poses a challenge for the current Chinese leadership under Xi Jinping. The official GDP target for 2023 was adjusted to 5% in March in response to signs of faltering growth. To address the slowdown, measures such as reducing stamp duty taxes, relaxing housing market restrictions, and cutting key interest rates have been implemented. However, major global players like Goldman Sachs, S&P, JP Morgan, and Citi have all revised their growth expectations for both this year and the next, indicating that China's economic challenges are expected to persist in the foreseeable future.
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Political economy and state-owned enterprises
The economic landscape of China is a realm intricately intertwined with its political dynamics, presenting a distinctive paradigm that sets it apart from many other nations. In deciphering China's economic trajectory, one must recognize that its ability to navigate current economic challenges is inherently tied to deliberate political choices. State-owned enterprises (SOEs) present a unique challenge due to their entrenched roles, political networks, and social security responsibilities. Reforming these entities is politically sensitive, requiring a careful balancing act to avoid adverse social and political consequences.
In December 2020, President Xi Jinping introduced the term ‘Disorderly Expansion of Capital’ reflecting concerns about uncontrolled and speculative growth within the economy. This phrase gained prominence, notably following the withdrawal of the Ant Group IPO, signaling the government's cautious approach toward rapid capital expansion. Scholars have long debated China's capacity for genuine innovation while the ruling Communist Party maintains a firm grip on economic activities, dictating what capitalists can or cannot pursue. This tension arises from the Party's overarching goal to steer the economy and concurrently foster innovation, often posing a delicate policy dilemma. Despite initial promises made during the third plenum of the 18th Central Committee in 2013 to allow markets to play a more significant role in resource allocation, subsequent years have seen a rollback of some of these commitments.
Another core economic concern in China is its high savings rate which exceeds 50% of income, reflecting a cautious approach to spending and consumption. Efforts to alter this behavior through social security measures have been slow to yield a substantial impact. Additionally, policies such as ‘Common Prosperity’ and ‘Dual Circulation’ aimed at fair wealth distribution and boosting domestic consumption have faced implementation challenges. The Evergrande crisis, which unfolded from 2020 to 2023, exposed the housing bubble in China, shedding light on misregulation and path dependency within the economic system. Concerns about a ‘middle-income trap’ and aspirations to ascend the value chain loom large and have affected China's long-term national targets.
Conclusion
China's economy is facing several challenges and the government needs to take several steps to address these challenges. One key area for improvement is domestic consumption. The government needs to boost domestic consumption by increasing income, reducing taxes, and expanding the social safety net. This would help to create a more balanced economy and reduce China's reliance on exports. Another key area for improvement is innovation. China needs to invest more in research and development and create a more supportive environment for startups. This will help the country to move away from low-end manufacturing and into higher-value-added industries. China also needs to strengthen its intellectual property laws and enforcement to encourage innovation and attract foreign investment. The government should also continue to reform the state-owned sector. The state-owned sector still plays a large role in the Chinese economy, but it is often inefficient and uncompetitive. The government needs to reform the state-owned sector by privatizing some companies and making others more efficient. This would help to improve the overall efficiency of the Chinese economy. China also needs to address its demographic challenges. China's population is ageing rapidly, which is putting a strain on the economy. The government needs to raise the retirement age, expand the social safety net, and encourage couples to have more children. This would help to ensure that China has a sufficient workforce in the future. In addition to the above, China can also improve its economy by investing in education and training to develop a skilled workforce, reducing bureaucracy and corruption to create a more business-friendly environment, and improving environmental protection to reduce pollution and improve the quality of life for its citizens. By taking these steps, China can improve its economic performance and create a more sustainable future for its economy.
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