Epidemic versus economy
China's economy in the second quarter grew by only 0.4% in annual terms, and analysts suspect that even these modest figures were faked by the authorities in an attempt to mask the crisis. In early March, the authorities set the GDP growth target at just 5.5% for 2022, the lowest since 1991. But even this goal now seems elusive. From April to June, Chinese GDP has already contracted by 2.6% compared to the first quarter. If the economic contraction continues (which largely depends on the poorly predictable epidemiological situation), that is, if the GDP declines for two consecutive quarters, the country will repeat the American experience and find itself in a technical recession. The International Monetary Fund (IMF) has already downgraded its 2022 GDP growth forecast for China to 3.3%.
The main cause of China's problems is called the actions of the authorities – namely the so-called zero tolerance policy for COVID-19, which involves the closure of industries, the complete self-isolation of citizens and the virtual cessation of the life of entire cities. For the Communist Party, this is a matter of principle. In the autumn, the country's leader Xi Jinping is preparing to be re-elected for a third term, and although the lockdown is an unpopular measure, he does not want to risk the epidemic getting out of control. With an underdeveloped health care system that risks collapsing with an influx of patients and causing more public discontent, the authorities continue to adhere to tough preventive measures.
In March, due to the outbreak of "omicron", large-scale lockdowns stopped the usual life in several industrial centers at once. The most acute problem for both the Chinese and the world economies was the two-month closure of the multi-million dollar Shanghai, the center of international trade and business within the country. Shanghai is, among other things, the world's largest container port, and the quarantine here has exacerbated disruptions in supply chains. As a result, the city's GDP contracted 13.7% year-on-year in the second quarter, while China's retail sales and industrial production fell in April to their lowest level since the start of the pandemic. The unemployment rate at the same time rose by 6.1%, reaching a two-year high.
Despite the fact that Shanghai "opened" in early June, new lockdowns in the country cannot be ruled out, especially given the pessimistic forecasts of the World Health Organization (WHO) for the fall and winter on the spread of the virus. Already, the incidence of COVID-19 is on the rise in many countries around the world. On the European continent, the number of new cases has tripled over the past month and a half, and the number of hospitalizations has doubled.
The construction crisis is pulling the economy to the bottom
Another headache for the Chinese authorities is the worsening crisis in the real estate market. In recent years, Chinese developers have found themselves in a debt hole and cannot cope with the payment of labor and materials for the construction of houses, as a result of which construction projects are greatly delayed. As a result, the number of buyers' refusals to pay mortgages for apartments in unfinished houses is growing. To date, clients have stopped payments on at least 319 projects in 93 cities — the first time the country has faced such boycotts by citizens.
Mortgage and bank funds are the most important source of developers' liquidity. About 90% of new real estate in China is being built under a prepayment scheme. According to investment banking firm Jefferies, construction in progress accounts for approximately 1% of total mortgage loans. If all buyers of this housing refuse to pay, then the volume of overdue loans will rise to 388 billion yuan ($57 billion). This situation, in turn, creates risks for the Chinese banking system.
Home prices have been falling for ten consecutive months, and no one knows when the decline will end.
Because of all this, house prices have been steadily declining for ten consecutive months, and no one knows when the decline will end. The construction sector is one of the largest in the Chinese economy, accounting for a third of GDP, 40% of all bank loans and half of municipal taxes. Therefore, the crisis in this segment of the economy inevitably affects both the financial system and the investment market, shares and bonds of construction companies are inexorably losing value.
Some economists are convinced that the collapse of Evergrande, the world's most indebted property developer, prevented by the Chinese government and central bank, is just the tip of the iceberg. Yes, bankruptcy could cause a domino effect, as happened in 2008 in the United States after the collapse of the investment giant Lehman Brothers, but the rescue of Evergrande does not mean a way out of the crisis, the financial difficulties of Chinese developers are already a systemic problem.
Growth in debt
To stimulate waning economic growth, China has moved to ease monetary policy, while the US and Europe, on the contrary, are reducing asset purchases and raising interest rates to fight record inflation. At the same time, it cannot be said that the global trend of rising consumer prices bypassed China – in June, inflation in the country accelerated to 2.5% in annual terms. This is the highest value since July 2020, but for China, saving the real estate sector is now a priority.
At the end of May, the People's Bank of China unexpectedly announced a reduction in the base interest rate on loans for a period of five years by 15 basis points, to 4.45%. This rate is key to mortgage lending in China. The decision was announced shortly after the release of official statistics, according to which Chinese property sales in April fell by 46.6% compared to last year.
So far, it has managed to stay afloat, among other things, thanks to large cash reserves, pressure on the banking sector and capital controls, which limits the possibility of its flight abroad. However, these measures are exhausting themselves. The World Bank has already expressed concerns about this: "There is a threat that China will remain true to the old scheme of stimulating economic growth through debt-financed investment in infrastructure and real estate." WB experts emphasize that such a growth model is ultimately unsustainable, and the debt of Chinese corporations and local governments is already too high. As a result, China's total debt could grow to 275% of GDP by the end of 2022.
China's total debt could grow to 275% of GDP by the end of 2022
Overtake the USA at any cost
Behind the traditional – and dubious – methods, there may be a desire by the Chinese authorities to overtake American economic indicators by all means. At the end of April, there were rumors that Xi Jinping gave officials the appropriate order to ensure that the country's economic growth outstrips the United States. The head of China wants the Chinese economy to look better than the economy of its main Western competitor, despite all the internal problems and the shutdown of entire megacities due to coronavirus policies. This is also why many do not believe the official Chinese statistics. Western analysts suggest that GDP growth of 4.8% is a fiction.
Western Analysts Believe Chinese GDP Growth Is a Fiction
The British company Pantheon Macroeconomics, based on publicly available data on prices in the country, believes that real growth is half as much – only 2.4%. Adding to the doubt is the fact that the Chinese authorities have never adjusted the GDP target in the middle of the year, and only once did not reach the target – in 1998, during the Asian financial crisis. In a word, the real state of affairs in the Chinese economy today can be many times worse than the government tells about it.
Adding to the problem is the aggravated escalation of the conflict around Taiwan due to the recent visit to the island of the Speaker of the US House of Representatives, Nancy Pelosi. The already strained relations between China and the United States have escalated to the limit. The stormy protest of the Chinese side turned into direct threats of military action. Now China intends to regularly conduct military exercises to blockade Taiwan. Before the elections in 2024, Xi Jinping cannot show weakness in any way.
From an economic point of view, the escalation of tension in Taiwan can lead to a shortage of semiconductors and a sharp rise in the cost of technological products, which will inevitably affect the state of the economies of China itself, the United States and the whole world. Now semiconductors are the main parts in the production of almost all household devices: telephones, computers, electronics in cars. Escalating conflict threatens global supply chains. The Taiwan Strait is the main route for shipping from China, Japan, South Korea and Taiwan to the west – through it, goods made in Asian factories are delivered to the markets of Europe, the United States and other countries.
Consequences for Asia
Regardless of Taiwan, the threat of economic recession affects not only China, but the entire Asia-Pacific region (APR). Economists polled by Bloomberg estimate the probability of a recession in China at 20% over the next 12 months, while its neighbors Japan and South Korea are a little less fortunate, where this figure is already at the level of 25%. The main reason is the trade deficit resulting from sagging exports. China is a key trading partner and sales market for both countries. It accounts for 27% of all South Korean exports and almost 22% of Japanese . Accordingly, the contraction of the Chinese economy automatically affects them. The situation is also aggravated by the slowdown in the economies of the United States and Europe, no less important trading partners for Japan and South Korea.
So far, both countries are coping well with the challenges. Thus, Korea's GDP grew by 0.7% in the second quarter against growth of 0.6% in the first quarter. Strong consumption largely offset scant exports, even despite a series of aggressive interest rate hikes. Japanese GDP in the first quarter sank by 0.5%, but in the second quarter it recovered sharply and grew by 2.5%. The reason was the removal of covid restrictions and the rapid growth of consumer spending.
However, inflation in Korea and Japan, although not catastrophic, still sets new records, as in the rest of the world. Consumer goods prices in South Korea rose 6.3% in July, the highest inflation since November 1998. In response, the Bank of Korea for the first time in history decided to raise the key rate by 50 basis points at once, and now it is at the level of 2.25% per annum. In Japan, which has largely struggled with deflation for the past 30 years, consumer prices peaked in May at 2.5%. Although inflation fell in June, it still remains above the 2% target. The Japanese authorities do not plan to do anything about this, they are still aimed at maintaining negative rates that have long existed in the country.
True, there is an additional cause for concern for the Japanese authorities – the rapid depreciation of the yen. The exchange rate of the national currency fell in July below the mark of 136 yen per dollar – this is the minimum value since 1998. The driver was the discrepancy between the super-soft monetary policy of the Bank of Japan and the expectations of tightening the policy of other central banks of the world, including the US Federal Reserve. Jim O'Neill, a former chief economist at Goldman Sachs , suggested that the rate could fall as low as 150 yen per dollar. According to him, this is capable of provoking shocks comparable in scale to the 1997 Asian financial crisis.
India has become the only major country in the Asia-Pacific region that is not yet threatened with an economic downturn. According to the consensus forecast, the probability of a recession in the country over the next 12 months is zero. To date, the country's economy is characterized by the stability of the financial system, the rise in the manufacturing industry and the service sector, and at least temporary stabilization of inflationary pressures. The coming rainy season and the presence of large stocks of grain also favorably affect.
The only country not yet in danger of recession is India
However, not all analysts believe that India will be able to avoid problems. This can be prevented mainly by the country's heavy dependence on oil imports. High energy prices are driving up inflation, which is becoming increasingly difficult for the government to control. In June, prices rose by 7% – from the list of major Asian economies, this figure is higher only in Thailand. If the trend continues, this will be another very bad news for everyone, but record deliveries of Russian oil at bargain prices soften the energy component in local inflation.