While the Chinese government has recently enacted stimulus measures to revitalize its flagging economy, many investors and economists remain skeptical of their long-term effectiveness. The measures provide a temporary reprieve to the current malaise and do not address the deep-rooted structural issues plaguing China’s economy. Unless more is done to address domestic consumption, the recent gains in the stock market are unlikely to hold.
Last month, the People’s Bank of China and financial regulators announced a wide-ranging stimulus package that included interest rate cuts, more liquidity for banks, additional property reforms as well as funding initiatives for the stock market. Financial markets reacted positively, but there are several reasons for the concern.
Stimulus Primarily Targets Existing Mortgage Rates, Not New Spending
The latest round of stimulus primarily focuses on reducing existing mortgage rates for homeowners. While intended to free up household income and stimulate spending, analysts doubt its efficacy. Goldman Sachs predicts that these rate cuts will provide approximately 50 million Chinese households with an additional $21 billion annually. However, the prevailing economic uncertainty makes it more likely that homeowners will utilize this extra income to pay down debts or increase savings rather than invest in the struggling real estate market or other sectors of the economy. Trimming existing mortgage rates will not be sufficient to restore investor confidence and revive the real estate market.
Eroded Investor Confidence Undermines Real Estate Recovery
Confidence in the real estate sector has been severely eroded. The real estate sector’s contribution to China’s GDP has plummeted from its peak of 30% in 2018 to approximately half that figure today. New home prices across 70 Chinese cities experienced a year-on-year decline of 5.3% in August 2024, following a 4.9% drop the previous month. The country has the equivalent of 60 million unsold apartments, which will take more than four years to sell without government aid, according to Bloomberg Economics. Although China’s central government urged more than 200 cities to purchase unsold homes to help ease this oversupply in May, only a fraction of the cities have responded to the incentives. Even with cheap funding, the math of buying excess inventory and turning it into low-cost housing just does not work.
Deeper Economic Concerns Overshadow Real Estate
The real estate market’s performance is tied to the overall health of the Chinese economy, and its troubles spill over into other sectors. High youth unemployment (which reached 18.8% in August), weak consumer spending, and low confidence in future growth create a negative feedback loop extending beyond the property market. While additional fiscal stimulus is expected to follow, the existing measures do not target these ongoing issues.
Overcapacity and Inefficient Investment Remain Unresolved
China has an ongoing problem of overcapacity in several industries which acts as a significant impediment to economic recovery. This overcapacity stems from an export-driven growth model heavily reliant on investment, often fueled by debt.
One example is in solar panels. China produces double the global demand for solar panels, resulting in low utilization rates and pressure to dump products onto international markets at artificially low prices. The construction of excessive production capacity, exceeding domestic demand, leads to inefficient resource allocation and diminishing returns on investment. This practice triggers trade tensions and calls for protectionist measures, further hindering economic stability.
The excessive investment in state-favored industries such as solar panels, electric vehicles and batteries has led to a mounting debt burden, especially at the local government level. This debt and declining revenue streams from sources like land sales create a significant risk to China’s financial stability. Local governments compete with each other to build factories that pump out commoditized products, often at low or negative profit margins, stressing the ability to service debt and limiting the ability to make additional investments.
Underconsumption And An Unbalanced Economic Model Persist
China’s long-standing economic model, prioritizing investment and exports over domestic consumption, has created an unbalanced and unsustainable system. Despite attempts to bolster domestic consumption, it remains weak compared to developed economies, hindering sustainable growth. Factors such as low wages, inadequate social safety nets, and income inequality contribute to this weakness.
The overreliance on exports makes China vulnerable to fluctuations in global demand and protectionist measures from trading partners. The current wave of trade tensions, particularly with the West, exemplifies this vulnerability. Brazil, Canada, Indonesia, Mexico, South Africa, Turkey, the United States, and the EU have all imposed tariffs on certain high-value-added Chinese imports. Even higher tariffs are a possibility, depending on the outcome of next month’s U.S. election.
Political Prioritization And State Control Crush Economic Dynamism
While the Chinese government’s tight control over the economy has driven significant growth in the past, it is increasingly viewed as a barrier to long-term sustainability.
The emphasis on state-owned enterprises and industrial policies directed by the CCP can stifle innovation and crowd out the private sector, which is crucial for driving growth and technological advancement.
President Xi Jinping’s common prosperity initiative to reduce income equality and narrow the wealth gap between rich and poor included a crackdown on large, powerful businesses and crippled entrepreneurial spirit. Overseas and domestic venture capital fundraising for China subsequently plunged. At the height of VC investment in China in 2018, there were more than 51,000 start-ups. That number dropped to around 1,200 in 2023 and is on track to be even lower in 2024. The destruction of the start-up culture will inevitably lead to slower technological innovation and further reliance on the old export-driven economic model.
It’s a matter of political choice. The CCP’s prioritization of political control and stability may lead to resistance against necessary economic reforms, especially those that might challenge the Party’s authority. This reluctance to embrace reforms that would reduce the state’s role in the market or implement robust social welfare programs to boost consumption further hinders sustainable growth.
Demographic Headwinds Add To Economic Strain
China’s aging population, a consequence of the one-child policy, presents a long-term economic challenge that the current stimulus package does not address. A shrinking workforce, rising healthcare costs, and a potential decline in productivity all add strain to the economic model.
Current forecasts project that China’s population will shrink by over 100 million people by 2050. By the end of the century, China’s population may decline to less than 800 million, with some scenarios putting the figure at less than 500 million. Over time, there will not be enough working-age labor to drive the manufacturing sector.
While the latest stimulus measures might offer temporary relief to certain sectors, they are insufficient to reverse China’s economic decline. Addressing the deep-rooted structural problems, including overcapacity, an unbalanced economic model, local government debt, an aging population, a return of the entrepreneurial spirit, and the need for greater economic liberalization, is crucial for achieving sustained economic recovery.
The question is whether China is willing to address these issues, primarily with fiscal policy, especially if they come at the expense of the CCP’s control and its vision for China’s global role. Until that happens, the current economic decline in China appears unlikely to be reversed solely by the latest round of stimulus measures. The blistering stock market rally may not last much longer.