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

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

The Chinese government is launching a series of measures aimed at boosting the economy, with leaders pledging on Monday to “adjust and optimize policies in time” for its beleaguered property sector, while pushing stable employment towards a strategic goal. The Politburo also announced pledges to boost domestic consumer demand and address local debt risks.

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

On a quarterly basis, economic output grew by 0.8%, slower than the 2.2% quarterly increase recorded in the first three months of the year. Meanwhile, youth unemployment reached a record high of 21.3% in June. On a slightly more positive note, industrial production growth accelerated from 3.5% year-on-year in May to 4.4% in June, comfortably beating expectations.

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

In recent weeks, the authorities announced a series of promises aimed at specific sectors or designed to reassure private and foreign investors of a more favorable investment environment on the horizon.

However, these were largely broad measures that lacked some key details, and the latest reading of the Politburo’s quarterly meeting on economic affairs struck a dovish tone but failed to make major new announcements.

Julian Evans-Pritchard, head of China economics at Capital Economics, said in a note on Monday that the country’s leadership is “clearly concerned”, with the reading calling the economic path “curvy” and highlighting the “many challenges facing the economy”.

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

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

“However, the absence of any major announcements or policy details suggests that there is no urgency or that politicians are struggling to come up with appropriate measures to support growth. Either way, it is not particularly reassuring for the near-term outlook.”

Triple shock

The Chinese economy continues to suffer from the “triple shock” of Covid-19 and prolonged lockdown measures, its ailing property sector and a raft of regulatory changes linked to President Xi Jinping’s “shared prosperity” vision, according to Rory Green, head of China and Asia research at TS Lombard.

With China still within a year of reopening from zero-Covid measures, much of the current weakness can still be attributed to that cycle, Green suggested, but he added that these could become entrenched without the appropriate policy response.

“There’s a chance that if Beijing doesn’t step in, the cyclical part of the Covid cycle damage could match some of the structural headwinds that China has — particularly around the size of the real estate sector, decoupling from the global economy, demographics — and push China further into a much, much lower growth rate,” he told CNBC on Friday.

TS Lombard’s starting point is for a stabilization of the Chinese economy in late 2023, but for the economy to enter a long-term structural slowdown, albeit not a Japan-style “stagflation scenario”, and likely to average closer to 4% annual GDP growth due to these structural headwinds.

While the need for exposure to China will remain essential for international companies as it remains the largest consumer market in the world, Green said the slowdown could make it “a little less tempting” and accelerate the “disconnect” with the West in terms of investment flows and output.

For the global economy, however, the most immediate spillover from a Chinese slowdown is likely to come in commodities and the industrial cycle, as China reconfigures its economy to reduce reliance on a real estate sector that has “absorbed and driven commodity prices.”

“Those days are gone. China is still going to invest a lot, but it’s going to be kind of more advanced manufacturing, technical hardware, like electric vehicles, solar panels, robotics, semiconductors, those types of areas,” Green said.

“The property driver – and with it, the pool of iron ore from Brazil and/or Australia and machinery from Germany or appliances from around the world – has disappeared, and China will be a much less important factor in the global industrial cycle.”

Second order impacts

The recalibration of the economy away from real estate and towards more advanced manufacturing is evident in China’s massive push into electric vehicles, which saw it overtake Japan earlier this year as the world’s largest car exporter.

“This shift from a complementary economy, where Beijing and Berlin kind of benefit from each other, to now being competitors is another big consequence of the structural slowdown,” Green said.

He noted that beyond the immediate loss of demand for commodities, China’s response to its shifting economic sands will also have “second-order effects” for the global economy.

“China still makes a lot of things, and they can’t consume everything at home. A lot of the things they make now are much higher quality, and that will continue, especially as less money goes into real estate, and trillions of renminbi go into these high-tech sectors,” Green said.

“And then the second-order impact, there’s not only less demand for iron ore, there’s also much higher global competition across a range of advanced manufactured goods.”

While it is not yet clear how Chinese households, the private sector and state-owned enterprises will view the transition from a real estate and investment-driven model to one driven by advanced manufacturing, Green said the country is currently at a “pivotal point.”

“The political economy is changing, partly by design, but also partly by the fact that the real estate sector is actually dead or if not dying, so they have to change and a new development model emerges,” he said.

“It won’t just be a slower version of the China we had before Covid. It’s going to be a new version of the Chinese economy, which will also be slower, but it’s going to be one with new drivers and new kinds of idiosyncrasies.”