Despite signs of recovery, weak demand remains a risk

• Status of China’s Economic Recovery – May saw a quick rebound in industrial production and fixed investment, while the decline in growth of services, retail sales and housing sales softened compared to April. Thanks to the relaxation of COVID restrictions and a series of stimulus measures, China’s recovery is likely to continue in 2H. However, the pace of this recovery will be constrained by the ongoing downcycle of the country’s property market and a weakening global economy – including what we expect to be a shallow recession in the US. As a result, we have revised down our GDP forecasts for China from 4.2 percent to 4 percent in 2022, and from 5.5 percent to 5.3 percent in 2023.

• Investment Trends –  Rapid investment recovery in May was led by the manufacturing and infrastructure sectors on the back of strong policy support, which was mostly leveraged by state-owned enterprises. Private sector investor sentiment remains weak due to COVID-related uncertainty and the weak growth outlook. With respect to the property sector, home sales are likely to stabilize in 2H, but this is unlikely to lead to a solid recovery in property development investment. Developers will continue struggling with overleveraged positions and liquidity constraints. 

• Consumption Trendss Retail sales growth continued in negative territory in May, though the decline softened compared to the previous month. This was thanks to a strong rebound in sales of food products and e-commerce sales, both of which benefited from improved logistics and a relaxation of COVID restrictions. Despite this, consumer sentiment remains weak, as reflected by low spending on non-essential goods and services. Looking forward, we expect Chinese consumption to remain subdued as a result of several headwinds including a recurrence of small-scale COVID outbreaks and the consequent restrictions under China’s ‘dynamic Zero-Covid' strategy; continuing weakness in the labor market and slow household income growth; and the persisting property market downturn.  

• Trade Trends – China’s exports rebounded strongly in May due to improved port operations and the shipment of delayed backlog orders. Growth, however, is expected to decelerate in 2H because of rapidly weakening external demand. We expect the value of the RMB to continue facing downward pressures as a result of expected interest rate hikes by the US Fed in the coming months, and monetary easing in China. In theory this should make Chinese exports more competitive, but the effect will not be enough to completely offset weakening external demand.

Implications for Business

China has faced a series of shocks since 2020, chief among them has been the COVID pandemic. The related restrictions on mobility have disrupted both the demand and supply sides of economy. This has been exacerbated by the property sector downturn, with many developers facing liquidity constraints and even defaulting on their debt. No wonder then that consumer confidence has weakened, and uncertainty in the business landscape has risen.   

Externally, the global economy is weakening, with central banks from developed economies responding to rising inflation by increasing interest rates. This will make it more expensive for developing economies to service the vast amounts of debt they acquired to respond to the economic impacts of COVID. We are expecting a recession in the US; while growth in the EU will be inevitably slower. China, which has been rolling out pro-growth measures intensively over the past six months, may find the policy room for further stimulus increasingly limited as they attempt to counter the negative shock that a global recession would bring. As if this were not enough, the geopolitical landscape has continued deteriorating, with the ongoing conflict between Russia and Ukraine being featured daily in media headlines. 

This will all add downward pressures to China's economic recovery in 2022-23. Not only do we expect the pace of recovery to be slower compared to the aftermath of the first COVID outbreak in 2020; but also, with a more limited policy room, Chinese authorities may have no option but to be increasingly tolerant of market volatility.