Economists Warn of U-Turn in China’s Recovery

By Nick Hedley

Until recently, China was expected to be on the cusp of an economic recovery, even as developed markets prepared for a possible recession. Now, however, economists are warning that China’s recovery is already fizzling out.

Following a spate of weak data points, China’s central bank unexpectedly trimmed its key interest rates by 10 basis points in an effort to stimulate the economy.

“The cut came just ahead of data which showed weaker-than-expected increases in retail sales and industrial activity in July,” Nikesh Sawjani, an economist at Lloyds Bank, said in a note, adding that house prices have also declined slightly.

“Rather than rallying on the prospect of stimulus, commodity currencies have softened on the view that China may not be the engine of world growth for some time,” said Chris Turner, global head of markets at Dutch bank ING.

Investors are also wary of new Covid-19 outbreaks amid China's zero-Covid strategy, which could herald the return of growth-sapping lockdowns, Turner said, adding that the renminbi could continue to weaken through key technical support levels.

Australian bank ANZ, in a note co-authored by Raymond Yeung, chief economist for Greater China, said weak data readings for July indicated “a stagnation in the economic rebound seen after lockdown restrictions were eased in Shanghai.”

The central bank’s surprise rate cut suggests that authorities are concerned about rising youth unemployment, the bank said. The youth unemployment rate surged to a historical high of 19.9% in July.

“Broad policy changes are required – ranging from government regulations over the property sector to the existing zero-Covid approach – in order to avoid another economic downturn in the third quarter, in our view.”

Retail sales contracted in real terms in July, credit data was “weak,” and industrial production and fixed asset investment growth declined, led by the private sector.

Property investment, especially by private developers, continues to shrink on the back of mortgage payment boycotts. Homebuyers in more than 100 cities have reportedly refused to fork out mortgage payments for unfinished apartments.

Following the unexpected 10-basis point rate reduction, ANZ expects a 50-basis point rate cut in the second half of the year.

“In our view, the impact of all the stimulus pledged so far is fairly limited,” the bank said. “A small interest rate cut is insufficient to boost domestic demand, letting alone the current policy rate has stayed below market rate for quite a while.”

ANZ’s data shows that Mainland China’s equity market recorded net outflows of $3.1 billion in July, partly reversing June’s inflows. Foreign investors also reduced their onshore China debt holdings for the sixth straight month in July.

“China’s weaker-than-expected second-quarter GDP growth and persistent Covid-related restrictions are dampening investor sentiment,” Khoon Goh, head of Asia research at ANZ, said in a separate note.

Meanwhile, foreign investors were net buyers of Asia ex-China equities and bonds in July, leading to the first monthly inflow since December 2021.