China's GDP Troubles Point To Need For Bolder Reform

“Unconvincing onshore activity momentum outside of the 'new' industries in May suggests that the recent step-up in property and fiscal stimulus has not yet improved consumer and investor
sentiment ,” says economist Louise Loo at Oxford Economics.

The external sector, meanwhile, is even more uncertain, even if mainland exports are on a tear. In May, overseas shipments increased 7.6% year on year at their fastest pace in more than a year despite intensifying US-China trade tensions.

“We expect Chinese export price deflation to provide a helpful tailwind in the struggle to bring emerging market inflation back to target,” says Tatiana Orlova, economist at Oxford Economics.

Trouble is, the global scene is awash in headwinds. In the US, the Federal Reserve's reluctance to ease means the“higher for longer” era for yields will persist indefinitely. Tokyo is skirting recession again, and at a moment when the Bank of Japan is mulling a rate hike. Europe is muddling along as Germany stagnates.

What's needed is a reinvigorated effort to recalibrate growth engines and incentives. Short-term stimulus is plenty needed, as evidenced by the marked downshift in mainland demand .

Many expect Beijing to intensify moves since April to encourage businesses and households to upgrade old machinery with government subsidies, with particular emphasis on automobiles.

“The upcoming implementation of the trade-in replacement scheme will positively impact household and business demand, hopefully inducing demand-led inflation somewhat,” says Kelvin Lam, an economist at Pantheon Macroeconomics.

Yet the main event will be the ways in which Xi and Premier Li Qiang telegraph plans to accelerate structural upgrades.

“The Third Plenum may conclude with a pledge of comprehensive reform in areas spanning the private sector, manufacturing, innovation, social security, economic management and more,” says Mark Williams, chief Asia economist at Capital Economics.“That may excite hope of substantial change but, in the Party's eyes, it has been engaged in comprehensive reform for the past decade.”

Carlos Casanova, economist at Union Bancaire Privée, adds that“while nobody can know the scope of reforms ahead of time, we expect to see changes to
housing
sector policies. An increasing number of cities have moved to completely abandon macroprudential restrictions on investment properties. The central government has so far remained silent, suggesting a more formal pivot during the summer months. Stay tuned for more.”

That“more” could include Beijing going further than it has to date to help highly indebted property developers, regardless of“moral hazard” risks.

Xi's top priority in 2024 is encouraging consumers to spend more and save less to keep growth near 5%. That means continuing to raise incomes and building more robust social safety nets to encourage spending. It means creating deeper, trusted capital markets so the average Chinese can invest in stocks and bonds - not just real estate.

Until now, Beijing's extreme focus on juicing consumption time and time again is counterproductive, many economists say. It leaves China susceptible to boom-and-bust cycles that require urgent attention at the expense of moving the economy upmarket. And China's heavy reliance on exports leaves the economy vulnerable to Washington's
trade-sanction antics .

Part of the strategy is accelerating and broadening China's evolution as a high-tech powerhouse, development experts agree. And indications are, this is precisely the pivot Xi and Premier Li Qiang are making as 2025 approaches.

Xi's“Made in
China 2025” vision has Beijing investing aggressively in making China the dominant power in 5G, electric vehicles, semiconductors, artificial intelligence, renewable energy and other dominant“future” industries.

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Yet unless China tends to cracks in its economic foundations, boom-bust cycles will remain a challenge for Xi's inner circle. Lam notes that a strong recovery in domestic demand will require bold moves to address“the current economic malaise” in the property sector and elevated local government debt levels.

“The
property
sector is a major problem,” says
Wei He,
economist at Gavekal Dragonomics.“Policymakers announced new support measures in mid-May, but the lack of subsequent improvement in daily sales figures suggests they will almost certainly need to do more to restore
homebuyer confidence .”

Odds are, He says,“policymakers may opt to wait, at least for now. They are not complacent about economic growth, as the Politburo's call in April for more support demonstrated. But with real GDP growth probably running above the full-year target of around 5%, they may not feel a sense of urgency either.”

To be sure,“that prospect is unwelcome to market participants,” He adds.“After a period of optimism starting in late April - primarily due to the Politburo meeting - equity and commodity markets have pulled back since around late May.”

To be sure,“there are no obvious catalysts for a turnaround in market sentiment until more policy support arrives, or the upcoming Third Plenum delivers an unexpectedly market-friendly outcome,” He says.“Unless the economic data worsen, policymakers may keep markets waiting.”

Follow William Pesek on X at @WilliamPesek

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