Challenges ‘far exceeded what Beijing predicted’
William Pesek says nothing would stabilise China’s economy faster than a weaker yuan and the yen’s drop makes this a tempting prospect for Beijing
The sweeping challenges that China is contending with have far exceeded Beijing’s predictions as the economy continues to navigate an “imbalance/ disequilibrium”, according to a leading economist who also stressed that – in light of these outsized factors – achieving 5.3 per cent growth in the first quarter was an odds-defying feat.
“Covid’s scarring effect has been deeper and broader than expected. Structural adjustments and upgrades are occurring quicker than planned. The fiscal standing of local governments is deteriorating quicker than thought,” said Liu Yuanchun, president of the Shanghai University of Finance and Economics.
“Also, seismic shifts, unseen for 100 years across the globe, are accelerating faster than predicted, with more non-economic risks emerging than economic risks,” the senior government adviser added, speaking at a forum in Shanghai on Tuesday.
Liu said China’s development in the recent past and the immediate future would be marked by such disequilibrium, and striking a new balance would take time.
He added that challenges arising in the post-pandemic era and from rivalries with other economic superpowers had been “more daunting” than those that unfolded a decade ago when China’s double-digit economic growth became a trend of the past, prompting President Xi Jinping to flag a “new normal” of moderating growth.
One indicator of the new uneven growth and transition has been overcapacity, with the producer price index declining in March by 2.8 per cent, year on year, while staying in the negative range for the 17th straight month.
“There is no sign that the PPI drop will narrow, either seen from a yearly or quarterly comparison base,” Liu said. “With imbalance comes risks and adjustments.
“The supply-demand disequilibrium is there, with the first quarter’s utilisation rate at 73.6 per cent – about 7 percentage points lower than the high utilisation range. So, we have capacity sitting idle.”
He called for new ways of thinking to assess overcapacity in new and strategic industries, adding that drastic cost reductions, on the strength of China’s ultra-large market size and emerging new business models, should be factored in as the issue garners international attention.
Liu also warned that the consumer price index, which grew in March by 0.1 per cent, year on year, after expanding by 0.7 per cent in February, was way off the level required to attain a supply-demand balance of 2-3 per cent. Beijing’s 2024 inflation target is 3 per cent.
Liu’s comments came after China’s better-than-expected 5.3 per cent growth in the first quarter indicated that the economy was slowly regaining momentum despite strong headwinds.
“[The growth speed] was a result not easily attained amid all of the risks,” Liu said.
Stephane Grand, founder of SJ Grand Financial and Tax Advisory, which serves small and medium-sized European and American enterprises in China, said that even with China’s 5.3 per cent growth, the benefits to those types of foreign firms “will not be immediate”.
“It will take a while, as people are still cautious,” Grand warned.
With a similar eye toward a future with persistent headwinds, Liu said the imbalance now engulfing the Chinese economy was here to stay.
Specifically, Liu said, the property downturn had been deeper and more persistent than previous rounds.
Property-sector investments fell in the first quarter by 9.5 per cent, year by year, with total sales slumping by 27.6 per cent.
“These declines came on top of the deep distress we saw in 2023 and 2022,” Liu said. “The days of the property sector being a ‘super pillar’ are gone. It used to account for 10.9 per cent of the GDP, but the share tumbled to 5.85 per cent last year.”
And in China’s search for new pillars, he added, contributions from new, hi-tech sectors such as electric vehicles have yet to fill the void.
As the Japanese yen tests its lowest levels since 1990, all eyes are on Tokyo to see if policymakers will act to break its fall. Instead, we should be looking at Beijing. Nothing would stabilise China’s economy faster than a weaker yuan. It would provide a quick and timely boost amid a deepening property crisis, deflationary pressures and record youth unemployment.
And President Xi Jinping might conclude that the yen’s drop affords China the geopolitical cover to engineer a weaker yuan.
Let’s hope Xi resists this urge. It’s not hard to count the ways such a move could backfire on the global economy in the short term and China’s development in the long run. The biggest is triggering the worst currency war in decades, which would slam bond and stock markets everywhere.
Consider why Xi and the People’s Bank of China have so far avoided yuan depreciation. For one, it would make offshore debt payments more expensive for property developers like China Evergrande Group. It would set back efforts to increase trust in the yuan and its internationalisation. And it would make Donald Trump’s head explode.
This latter risk looms large in Beijing. The party line is that proud, rising China bows to no one and that Xi’s Communist Party will act as it pleases. In reality, Xi’s inner circle wants to avoid becoming a central topic in America’s coming presidential election.
Nothing brings together US President Joe Biden’s Democrats and the Republicans loyal to his predecessor, Trump, faster than being tough on China. Just look at the speed with which Congress acted to clamp down on ByteDance-owned TikTok. China is already a big talking point on the campaign trail as Biden and Trump talk trade, wages and security. A weaker yuan would turn even more attention Beijing’s way, and in ways that pull Japan into the fray, too.
As Xi absorbs the implications of what Biden and Japanese Prime Minister Fumio Kishida discussed in Washington last week, he might be most vexed about what they didn’t: a plunging yen.
How could the US label China a currency “manipulator” when ally Japan is an even bigger offender? Beijing would have reason to scream “hypocrisy!” early and often – and without irony.
Already, Trump is threatening 60 per cent tariffs on all mainland Chinese goods. He plans to revoke China’s “most favoured nation” trade status. Elon Musk is lobbying hard for tariffs on electric vehicle imports. The Tesla founder argues that BYD and its mainland peers will “demolish” US carmakers. Trump will almost certainly oblige.
A pivot towards a weaker yuan might have Trump and Biden vying to go one better on punishing China’s beggar-thy-neighbour gambit. Yet the bigger risk is that it could trigger devaluation moves across Asia and beyond.
Policymakers from Bangkok to Washington have feared a moment like this for a quarter of a century now. At the height of the 1997 Asian financial crisis, the biggest worry was China entering the race to the bottom.
Back then, officials at the US Treasury and International Monetary Fund practically begged China not to devalue, as Indonesia, South Korea and Thailand had done. The fear was that a yuan devaluation would cause a dangerous domino effect. And the economies that had avoided the worst of the crisis – like Malaysia and the Philippines – would fall next.
That didn’t happen, thankfully. But China’s economy circa 1997 wasn’t facing the daunting challenges it does today.
China’s property stumble echoes Japan’s bad-loan debacle in the 1990s. Just as with Japan, it is generating deflationary pressures that Beijing is struggling to address.
Naturally, many economists worry that China is failing to heed the lessons of Japan’s lost decades – namely, acting quickly and with overwhelming force to dispose of bad assets. Xi’s team has been slow to cleanse property developers’ balance sheets and tackle trillions of dollars of local government debt excesses.
This gets at why a weaker yuan would hurt China’s economic development in the longer term.
If currency devaluation were a ladder to vast riches, Argentina and Turkey would be Group of Seven nations. Despite the yen’s over 14 per cent drop over the past year, Japan’s economy is barely growing. In February, household spending fell for a 12th consecutive month.
Tokyo spent the past 25 years prioritising a weak yen over structural reforms. This took the onus off all the past 12 Japanese governments since 1998 to cut bureaucracy, modernise labour markets, catalyse a start-up boom, increase productivity and empower women. It deadened the urgency for corporate CEOs to restructure, innovate and take risks.
China must go the other way. Here, it’s worth rolling out the cliché that China risks getting old before it gets rich. Wealthy, highly developed Japan chose homeostasis over disruption. China’s unbalanced economy doesn’t have the luxury of relying on massive corporate welfare – which is what an artificially undervalued currency is – for growth. It’s a recipe for mediocrity, less productive industries and more boom/bust cycles.
With any luck, Xi’s inner circle is studying these lessons very closely and planning to hold the line on exchange rates. Japan isn’t making it easy though, as the yen ticks lower.
Kishida’s team would be wise to guide the yen higher, even just modestly. It would calm nerves in Beijing and head off the risk of a currency war that would upend an already fragile global economy. And it would perhaps finally close the books on the 1990s, a time few in Asia want to revisit.