Growth recovery to remain bumpy
China’s economic recovery from Covid was uneven and bumpy in 2023, and the growth momentum going into 2024 will remain difficult. The reopening boost to the Chinese economy has been weaker and shorter than expected, leading to an incomplete rebound. In 2023, the Chinese economy expanded 5.2%, slightly exceeding the official full-year growth target of “around 5%”. Economic expansion was mostly driven by total consumption (54% of GDP in 2022). Private and public consumption contributed over 80% of the GDP growth in 2023, followed by nearly 30% from investment (44% of GDP in 2022). Net exports were the main drag on GDP, in contrast to the previous years since 2019, and took 0.6 percentage points off the growth rate. This is because of a recovery in services imports (outbound tourism rebound) and weakened goods exports.
This fragile recovery attracted the attention of the Chinese leadership. Since August 2023, the authorities have announced a series of incremental policy support for the economy, covering a range of areas such as fiscal, monetary, housing, and equity markets. Growing concerns over the recovery momentum led the government to take an unexpected decision in October 2023 to issue 1 trillion yuan (0.8% of China’s GDP) in special central government bonds by the end of that year, which will raise the 2023 budget deficit to 3.8% of GDP, up from the implicit ceiling of 3%. China’s economic recovery is faced with insufficient domestic demand, which has not offset the drag from weak external demand. Part of the weakness in domestic demand stems from the housing market correction, which affects consumption, investment, job market and confidence. Job market conditions have deteriorated. Urban youth unemployment hit a record high of 21.3% in June 2023 before the release of this official data was suspended. After a methodology review, the resumption of the data release saw the youth jobless rate fell to 14.9% in December. Surveys from the central bank and National Bureau of Statistics have reflected weak job prospects and weak confidence. This has affected consumption. Retail sales rose 7.2% y/y in 2023, below the pre-pandemic average of 9.5%. With 70% of China’s household wealth being held in real estate, the ongoing real estate crisis will continue to dent consumer confidence and erode purchasing power for several years. Real estate and related industries generated around 30% of GDP. Real estate investment and sales continued to decline throughout 2023 as developers grappled with high debt, payment defaults and dwindling home sales (especially in lower-tier cities). This led to the authorities stepping up support for the ailing sector from mid-2023 after unveiling a comprehensive rescue plan in November 2022. Bloomberg reported that the People’s Bank of China (PBOC) plans to provide at least 1 trillion yuan of low-cost financing through the policy banks to boost the housing market. In December 2023, the PBOC made 350 billion yuan available in loans through its Pledged Supplementary Lending (PSL) facility to the three policy banks (China Development Bank, Export-Import Bank of China and Agricultural Development Bank of China). The central government is also reportedly working on a draft list of 50 developers eligible for bank financing support.
The underlying problem for Chinese economic development is structural. China is going through a secular deleveraging of its economy. It has been far too dependent on debt to drive growth, especially in real estate. Debt of the non-financial sector (households, government, non-financial corporates) ballooned from 139% of GDP in 2008 to 313% as of Q3 2023. China has been trying to transition from investment into more sustainable forms of growth, including consumption and higher added-value manufacturing. The move gained greater urgency in recent years amid an ageing population and rapidly diminishing returns from capital accumulation.
Shift in central-local fiscal imbalances
China approved a 1 trillion yuan increase in its 2023 fiscal deficit, effectively raising from an implicit ceiling of 3% of GDP to 3.8%. The increase in the fiscal deficit through the issuance of central government bonds is unusual because it has only happened three times over the past 25 years (1998, 2007, 2020), and under major crises or to accomplish major policy goals. The proceeds of these additional 1-trillion yuan central government bonds will be transferred to local governments (500 billion yuan each in 2023 and 2024) for spending in the rebuilding of disaster-hit areas and improving disaster relief capacity. This policy move is consistent with the government’s priority task to address local government debt problems. From a reform perspective, it is also an early step to tackle the imbalance between local governments’ spending responsibilities and their revenue allocation. In 2022, local governments spent 86% of total expenditure but only collected 53% of total fiscal revenue, reflecting their sustained and growing fiscal deficits that have prevailed since the 1994 fiscal reform.
The fiscal situation of local governments has deteriorated due to an evaporation of non-budgetary financing sources, especially land sales and local government financing vehicle (LGFV) borrowing. Local governments have amassed “hidden debt” (or off-budgetary borrowing) estimated by the IMF to be as much as over half of China’s annual GDP. The “hidden debt” problem of local governments is a major source of concern for the Chinese leadership, and a policy priority.
The current account surplus has narrowed in 2023. Weaker goods exports resulted in a smaller trade surplus. This narrowing of the trade surplus was amplified by the services deficit which widened to near pre-Covid level, aided by reopening borders and the tourism recovery. The larger current account surpluses over the pandemic years (2020-2022) were likely one-off, and unlikely to repeat due to secular factors. Current account is a function of the difference between national savings and investment. With national savings expected to return to its long-term declining trend amid an ageing society, the current account balance should remain close to zero in the coming years. Meanwhile, China also recorded its first-ever deficit in net foreign direct investment in the third quarter of 2023, according to balance of payments data. This reflected capital outflows pressure amid de-risking moves after foreign firms repatriated profits due to more attractive interest rates elsewhere. Consequently, the yuan depreciated in early September to its weakest level since 2007.
Renewed anti-corruption campaign
Xi Jinping secured a norm-breaking third term as General Secretary of the Communist Party of China (CPC) in October 2022, with the politburo standing committee, the highest decision-making body of the CPC, endorsing four newcomers (Premier Li Qiang, Cai Qi, Ding Xuexiang and Li Xi), all known to be allies of Xi. Additionally, Shanghai Party Chief Li Qiang became the Premier after the annual session of the NPC in March 2023. The outcome of the 20th Party Congress highlighted Xi’s prevailing dominance within the Party, suggesting that recent troubles, including economic woes, discontent with the zero-Covid policy, and increasingly strained relationships with Western advanced economies, failed to loosen his grip on power. There was no mention of a designated successor, which hints at the possibility of Xi holding on to power beyond a third term. Xi has also vowed to step up a crackdown on corruption in key sectors, which includes finance, energy, and infrastructure, as well as the military.
The recent sackings of some of China’s top officials, including foreign minister Qin Gang and defence minister Li Shangfu, reflected the current diplomatic and military leadership shifts. China’s military recently saw several high-level officials and generals removed from their posts, such as Commander of the Strategic Support Force General Ju Qiansheng, PLA Rocket Force commander General Li Yuchao and deputy General Liu Guangbin. The deepening purge, however, could be seen as an important step to secure the reliability of the military in preparing China for modern-day warfare.