China’s stress test

William Pesek says Beijing showed no urgency at the NPC meetings to reboot or stimulate its economy in a way that would help support its growth target

When Chinese leaders announced a 5 per cent growth target on March 5, they probably didn’t expect to have to defend it. Global asset managers complained that more “forceful” steps were needed to boost growth. And disappointment was felt in some Asian markets that had hoped for a more vigorous response.

The figure of around 5 per cent isn’t the problem. It’s that neither President Xi Jinping nor Premier Li Qiang appear to have an urgent plan to achieve it. No large-scale stimulus, no fresh strategies to address the property crisis or youth unemployment, and zero new tactics to recoup stock losses since 2021.

Xi and Li did telegraph reforms to come during the National People’s Congress (NPC) session. Plans to generate “new productive forces” will see Beijing developing game-changing industries from electric vehicles to renewable energy. This could mean a great leap forward for innovation and growth.

Yet the economy needs a solid foundation first. In a March 7 report, Fitch Ratings raised the spectre that cracks in China’s foundations could lead to a “severe downside stress scenario” that would have a “dampening effect on international price pressures”.

Nowhere is this stress test a greater concern than in Japan, which narrowly avoided yet another recession. In January, household spending plunged 6.3 per cent from a year earlier, the sharpest drop in 35 months.

The only thing arguably falling faster than economic sentiment in Japan is Prime Minister Fumio Kishida’s approval rating. Losing hope that China will be exporting growth makes it harder for Kishida’s Liberal Democratic Party. It also complicates the Bank of Japan’s (BOJ) ability to begin normalising interest rates.

Over in South Korea, President Yoon Suk-yeol’s government is struggling to keep growth from falling below last year’s 1.4 per cent. On top of China’s downshift, South Korea is finding it can rely less and less on Europe as powerhouse Germany struggles to keep recession at bay. In the US, the Federal Reserve doesn’t seem ready to cut rates as widely expected.

Southeast Asia’s most export-reliant economies are having to make things up as they go along. Already, purchasing managers’ data in Thailand, Malaysia and Myanmar are below the 50 mark, which means activity is contracting.

At the moment, Indonesia, the Philippines and Vietnam are in the black in terms of manufacturing activity, but arguably not for long as Chinese import demand craters and deflationary pressures persist.

This latter risk explains why so many economists can’t help but see China’s tomorrow through the lens of Japan’s yesterday. Missing during last week’s economic conversation at the NPC meetings were signs that Beijing would avoid Tokyo’s mistakes.

When Japan’s “bubble economy” imploded in 1990, the BOJ and Ministry of Finance were slow to grasp the fallout to come. China can’t afford a similar blunder. Just as Fed officials erred by thinking US inflation was “transitory”, the People’s Bank of China is making a mistake in thinking deflation will take care of itself. This denial leaves Asia with too many wild cards to contemplate. One is the trajectory of China’s currency when the weak yen is giving Japan a big competitive advantage.

Might Xi direct the PBOC to engineer a more stimulating exchange rate?

If so, it would further complicate export dynamics from Seoul to Singapore. Then there’s the geopolitical minefield ahead of the November US presidential election. Expect President Joe Biden to continue layering on fresh moves to limit Chinese access to semiconductors and other vital technology.

Donald Trump, meanwhile, promises to impose a 60 per cent tax on all Chinese goods if elected again. Beijing is sure to expect the unexpected should Trump return to the White House, especially since the continuing fight between Democrats and Republicans over funding a US$34 trillion national debt already has Moody’s Investors Service threatening to take away America’s last AAA rating.

All this matters because global shocks may stress-test China, too. If events in Ukraine, the Red Sea or with Sino-US relations deteriorate and slam world markets, neither China nor much of the rest of Asia seems ready to withstand the increased turmoil.

Hitting a Chinese economy as unbalanced as the one Xi and Li are leading could prove disastrous. Between the default drama plaguing property, a stock market some on Wall Street worry is “uninvestable” and the US$9 trillion mountain of local government financing vehicle debt, now hardly seems the time to test China for weaknesses.

Unfortunately, the NPC has done little, if anything, to demonstrate China is fixing cracks in the financial system to support new efforts to raise its economic game. Nor does Beijing seem willing to deploy stimulus to head off deflationary forces in the short term.

It’s not what officials from Tokyo to Kuala Lumpur had hoped to hear from Beijing. But the message is loud and clear: neighbours, you’re on your own.

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