They discuss the prospects for policy easing, the state of local government finances, and internationalisation of the renminbi.


Paul Diggle, 00:10

Hello and welcome to Macro Bytes, the economics and politics podcast from abrdn. My name is Paul Diggle, Chief Economist at abrdn.


Luke Bartholomew, 00:18

And I'm Luke Bartholomew, Senior Economist at abrdn.


Paul Diggle, 00:20

And today we're talking about the state of the Chinese economy. So, last episode, we covered long-run global growth and the important driver that APAC and China represent for the long-term, global economic outlook. But on a shorter-term horizon, the Chinese reopening recovery has been showing signs of flagging recently, and markets have also been somewhat disappointed by this development. So we're going to drill into what's driving this – whether China's recovering service sector can be an impetus for growth for the rest of this year. And Luke and I are delighted to be joined by Bob Gilhooly, our Senior Emerging Markets Economist


Bob Gilhooly, 08:24

Hi Paul


Paul Diggle, 00:25

.. and special guest, Jonathan Anderson, Partner at Emerging Advisors Group, a macroeconomic consultancy that provides research on EM economies. John's worked at UBS, at Goldman Sachs and at the IMF. He's covered China, Russia and the EMs in a great amount of detail. And we're keen readers of John's research here at abrdn. So we're delighted to have him on the podcast. Welcome, John.


Jonathan Anderson, 01:28

Thank you, Paul. It's great to be here.


Paul Diggle, 01:30

So John, I want to start then by asking you about whether China's reopening rebound really is fizzling out? Is anything more than just a mechanical softening, after that initial spurt of growth coming out of COVID-19, going on here?


Jonathan Anderson, 01:48

Well, it's an interesting question. And really, there are two big things to say about China's recovery at home. Number one, is that if you just look at the good old services stuff – people were cooped up in their flats, they weren't able to travel and weren't able to leave. That reopening is ongoing and things are going all right. You've got people travelling again, you've got people getting out and about into the shops. So if you look at retail spending, if you look at domestic passenger volumes – they've rebounded nicely and sharply and they continue to rebound. So that sort of mechanical reopening of the economy is going on at pace. And that is not a worry from our side; we're not there yet. The Chinese still are not doing external tourism yet; we haven't got flights back up and running; there are a lot of other areas where you're still in the middle of it. But fast forward three months/six months/nine months, and China does kind of get back online as everyone else in the world has got back online. And that's all good. So that's the good news side of the recovery. The bad news side is on the all-important property market and sentiment in terms of new construction and new investments, and all of that good stuff. And there things are very, very different. And this, to be clear, is the sector that really matters. When we think about China and APAC driving the rest of the world and driving growth, it really is more about commodity demand and import spending. All of that is much more heavily tied to property construction and the investment side of the economy than it is to all of those good services things. So, we care a lot about what happens in terms of investment spending in the property sector. And unfortunately, things are still very, very weak. Property sales and activity collapsed last year; people were just not buying at all, not taking mortgages, not committing to residential housing and other property, commercial property, as an asset. You had a little bit of a rebound in February and March; when you first had the reopening, a bunch of transactions kind of went through. But now you parse what we've seen in April and what we're seeing in May and June: things are just right back down to the bottom. Sentiment is still very weak. There are a lot of uncertainties in China. There are uncertainties about what's happening domestically in terms of governance and policy. We're not getting big stimulus and commitment from the government yet – they're sort of standing back and waiting to see what happens elsewhere. The geopolitics are bad. And there's a lot of questions about where US/China and Russia/Ukraine go. People are just not putting money to work yet in China. And we don't know where this goes and how much or how long it's going to take. But that part is just not really rebounding at all at the moment; it's just still sitting right along the bottom and that's the big question mark and what we're all waiting to see for where China goes.


Paul Diggle, 04:56

And on the surface is recovery, which is ongoing. Services sectors elsewhere in the global economy have been very strong over the first half of 2023, and part of that story has been excess savings coming out of the pandemic. What does China's excess savings picture look like? And is that a reason to think that you can continue to get a very strong service sector recovery for the next six months to next year?


Jonathan Anderson, 05:26

Well, interestingly, that goes back to property as well. If you look at household balance sheets and income statements before the pandemic, Chinese households have a very large gross saving balance. They consume a smaller part of their income, but their net savings is not very big – actually, it had fallen to roughly zero because with the money that they weren't spending on service and consumption, they were spending on housing. The housing boom in China basically sucked up all of the available savings in the economy coming from the household side. And of course, last year, that collapsed, so property demand fell off by about half. And suddenly, if you look at the household balance sheet, they're sucking away a lot of money. Because again, they're not spending it on property like they used to. And so now you have cash that's picking up and accumulating in the banking system. And, one of the big bull arguments coming into 2023 is that households suddenly have a lot of cash and there's a lot of savings that have been built up over COVID-19. And they're going to want to put that to work. They're not putting that to work in property; they're not getting back in and fuelling the housing boom the way they were three or four years ago. So the question is: will they now spend more on services and spend more on consumption and spend more on other things? Or are they going to just keep this as a precautionary savings, and wait and see what happens to China and the world economy? It's early days, because we're still getting online and getting back up to speed. We're still trying to get back to pre-COVID-19 benchmarks before we can talk about additional strength and boom. So the jury's still very much out. But it is true that households have money to spend in the sense that they're not spending it on property assets at the moment.


Luke Bartholomew, 07:16

So Bob, bringing you into the conversation, then. As John said, we haven't seen yet a big policy easing from China, but given that somewhat troubling growth backdrop that he described there, there does seem to be growing calls for policy stimulus. So, I'm wondering, first of all, what your thoughts are on the likelihood of any significant policy easing? And if there were to be, how would that fit within the longer-term Chinese policy objectives around de-risking? And then secondly, taking maybe a step away from that, at times, it can be quite difficult to even measure the stance of policy given the various different policy levers that policymakers can use at different times. What's the right way of even thinking about and measuring what the overall stance of policy even is?


Bob Gilhooly, 08:07

Thanks. I might actually take those in slightly the reverse order, just because I think the answer to the second one will help with your first question there. Kind of taking a bit of a step back, it's always a very tough call to judge the policy stance in China, even in that kind of backward-looking sense. There's lots of policy levers that can get pulled at any one point in time; the authorities are very much willing to pull both the price and the quantity side in financial markets, be it interest rates, as in other countries, or just a quantity of credit. And you shouldn't forget about the regulatory backdrop as well, which can make such a big difference, as we've seen in property and as John was discussing there. And then, add into that complication, the ones that are actually used as the primary instruments have varied quite a lot over time. And there's some good reasons to expect that the impact of these are going to vary over time too reflecting structural change in the economy and also change within financial markets. So our preferred approach is to summarise a bit more by looking at what's actually the impact. We can do this via our China financial conditions index, where ours is a little bit different from others out there in that we strip out an estimate of real equilibrium interest rates from our policy variables. Now, this helps on a couple of fronts. Firstly, it helps account for the downward trend and yields and policy rates that we see over time. And secondly (and relatedly), it also helps explain why some sections of the economy might still be struggling. So, for example, our financial conditions index has only just returned to about neutral in April, whereas if you didn't account for these falling real rates, you might maybe mistakenly conclude that financial conditions have loosened sufficiently, which wouldn't sit very well with the growth outturns last year and also some of this sector-specific weakness that’s coming through. Now, given past policies could still come through with a lag – we have seen the credit impulse improve quite a lot within the first four months of this year. On the one hand, that might temper policymakers’ desire to do a bit more. Paul and John mentioned there the excess savings that households are sitting on. But with little sign I guess of reopening causing inflationary headaches, as we've seen elsewhere, a still struggling property sector and some weakness on the industrial side. I think with all that it's a fairly easy conclusion that some more loosening is quite likely to happen. We've actually just had an announcement last week of a few measures there to support electronic-vehicle sales. And the authorities have actually flagged that a bit more is coming on the housing side, too. But that said, I think it still seems likely that the authorities are going to be wary of losing progress made on de-risking the economy, growth is just not as high up there on the list of policy priorities, as it used to be, in part reflecting geopolitical tensions. And I think there’s some fairly substantial fiscal holes to potentially constrain enthusiasm for some more substantial easing there, too.


Luke Bartholomew, 11:20

So John, shifting gears a little bit, I wanted to ask you about the state of local government financing in China, because for some people, this is quite a significant source of concern. Local governments seem to shoulder a lot of the burden from mass testing pushing up costs, and then their revenue being squeezed by lockdown and the de-risking of the property sector squeezing revenue from land sales. Yet, you've written about the myth of the crisis of Chinese government financing. So, I wonder if you could just sort of talk through your thoughts around that?


Jonathan Anderson, 11:54

Yeah, it's a very interesting topic. There are a couple of quick things that I'd like to stress. Number one is: if you think about what's happened over the last decade, you have this massive amount of stimulus borrowing, and most of it at local government affiliated finance companies, and infrastructure plays construction outfits. You have banks just shoving a lot of credit into these rats and mice in China, and most of them at the behest of local governments – that's how stimulus has normally been carried out. And most of that goes bad. Over the past decade, you see massive bad credit being created. And then over the past five/six years, China tightens up, starts to focus on winding these down, you start to recapitalise banks. And so, stage one is that you write down a lot of these bad debts from local government finance vehicles, and that ends up going onto the books of local governments. And so local government debt outstanding starts to go up quite a lot. And you worry about how local governments are going to pay for that. And now, of course, you have property downturn. And local governments do take in quite a bit from land sale revenues, and it's unclear whether that's going to be recovering sharply, given how weak property demand in the housing sector is today in China. And all of that seems very concentrated on local governments books and balance sheets. And it's not small – we're talking about something which is on the order of 40/45% of GDP. The good news, if you will, in China, is that most of this stuff – again, as local governments start to come up on problems and financing difficulties in terms of their debt loads outstanding and drop in revenues – is going to make its way eventually to the central budget. This is not really a local crisis, per se. Again, if you look at overall fiscal capacity in China, you still have a decent amount of room at the aggregate level, and again, the central government in terms of their revenue intake and how their funding is doing better in China today; things are not that bad. So in the near term, we downplay the risks of a fiscal collapse or crisis or default, because again, the aggregate consolidated balance sheet still looks better in China. The second point to make, specifically on the property and the land sales issues, is that yes, local governments historically get a good chunk of their revenue from land sales, but they have a lot of tied and earmarked expenditures that go with this, that go right back to clearing that land, resettling people, new construction, commitments and subsidies that go to construction on the land. And so, on a net basis, a lot of the land sale revenue is going to related expenditure. You're not actually using that to pay for civil servant wages and other normal budgetary needs. And so when land sales collapse and things fall off, so do a lot of the expenditures that are related. You're not going to be clearing land, you're not going to be resettling people, you're not going to be providing new funds for construction and subsidies to developers etc. So the net impact is also a good bit less than a lot of people realise. As a result, it's not pretty. There's a lot of debt out there and there's a lot of bad debt that's been created. But at the end of the day, for us, it just falls short of a looming default crisis that engulfs China and collapses the economy. It's going to be dealt with in a much more orderly manner, and there are lots of balance sheets in the backdrop that can be used to fund and finance. So, we keep an eye on this, but it's not Armageddon.


Luke Bartholomew, 15:50

And, John, I want to ask you more about the prospects for the real estate sector, because you highlighted how it is the weak spot of the post COVID-19 recovery, various measures of real estate activity are actually not far off some of their Shanghai lockdown lows, on some metrics. So, what are the prospects for that sector? I would presume that Chinese consumer confidence should be recovering at this stage of its reopening rebound? Is that going to play into a stronger real estate sector ultimately? Does it, by contrast, take policy stimulus eventually to do that job? And how does that interact with the broader de-risking agenda in the property sector?


Jonathan Anderson, 16:37

Yeah, that is the main issue in China. And it's complicated by the fact that policy can help. But at the end of the day, you have to convince households to go back and buy. People need to have confidence to take a mortgage, to put savings to work and to get back in and commit to buying housing. And there's no guarantee. Things are still very weak, surprisingly weak, actually. We thought we would see a bit more of a trend pickup. No one is taking a mortgage today and people are just staying away – visibility is low. So, I guess the first thing to say – and this goes back to what Bob mentioned – obviously we're going to get more stimulus coming through…you have to, you can't let this sag at these levels and continue to be as moribund as it is. And you're already seeing some regulatory changes and other measures aimed at trying to get property moving. But eventually, bigger guns may have to be brought to bear. It'll be very interesting in the second half of the year and going into 2024. If you don't get property recovering, this is a big part of the economy and a big driver of construction and investment spending. And, they're not really super focused on this right now. They've been content to let services recover, and GDP growth is still positive. And that's all good. But as you get toward the end of the year, you wake up and everything else is sort of back on track. But property is dragging things down, and you're going to have to find ways of trying to get people's confidence back and put more stimulus in, be it through interest rates, through subsidies and other measures, to try and get this going.


Luke Bartholomew, 18:21

Bob, so with that kind of context set, I want to ask you about whether China's growth this year/next year can have positive spillovers into other emerging markets and into the broader global economy? If I think back to the post-financial crisis recovery, China was very much a tide that lifts all boats. But this seems like a different recovery this time around.




Bob Gilhooly, 18:48

Yeah, I think it kind of seems unlikely that China can really be this tide that lifts all boats. I mean, yes, relative to a still-locked-down China, its trading partners are getting a little bit of a boost. I think it's tough to argue that China's really a big driver here, because there's big headwinds to construction, not least from the real estate side, but maybe also a bit of a retrenchment and public infrastructure spending, depending on how local governments are feeling. But I think the key point is the services-dominated recovery just really implies that Chinese GDP is going to have a pretty low, import intensity. So that typical link that we think of between Chinese growth by trading commodities to other countries just seems much weaker than normal due to these compositional effects. If you look at trade data we've had so far this year, Chinese import volumes did recover somewhat in the first four months of the year versus their Q4 troughs, around about 3-4%, we think, but that's pretty tepid when you consider the improvement in exports – they were up about 12%. So that clearly is going to drive some demand for intermediaries as part of that kind of re-exported trade. And then also just the rebound and GDP. So, in sequential terms, Q1 is up 2.2% quarter on quarter, 9.1% annualised. You might have expected maybe a bit more to come through on the import side there. Indeed, if we look ahead through the rest of this year, you can do a bit of work here thinking about import intensity using input/output tables, as we've done, combine them with our sectoral forecasts. It doesn't actually look like there's that much more coming through on the import side, from China to the rest of the world. And FX markets maybe back up some of this gloomy take on the state of Chinese and global manufacturing too; we’ve seen some pretty decent falls in the renminbi versus the dollar, and also on a trade-weighted basis since February. Maybe the one bright spot would be it's not all a manufactured goods and raw material story. As John mentioned, we've seen this rapid return of domestic travel within China. But the return of Chinese tourists abroad has been a bit delayed by capacity constraints on international travel and a few aspects: the bottlenecks around getting passports and visa issuance, too. This does seem like very much a question of when and not if Chinese tourists return and clearly that can be a pretty decent boost for many countries’ tourism sectors, potentially over the second half of this year and into 2024. I guess the wrinkle in that would be that it might not always be welcomed by the monetary policy authorities in the countries as tourism flows could clearly push up on services prices further, adding a bit more stickiness to core inflation, which is a bit of a problem in much of the world.


Luke Bartholomew, 21:44

So John, as a final question, I’d like to talk about a somewhat longer-term issue. And that's around the possibility of the BRICS club trying to develop an alternative financial architecture to the dollar. And I guess that's been an objective of some of those countries for some time. But perhaps the efforts have stepped up recently in light of Russia's invasion of Ukraine, and the way in which dollar power in the global system was used as a means of the US, and the West more generally, being able to exert foreign policy power. And there's definitely been a lot of discussion in the media recently about perhaps the dollar being supplanted. So, how do you think about some of those issues and whether the RMB is going to have a growing role within the global financial system?


Jonathan Anderson, 22:33

The super interesting and timely question, and there are many, many things to say here, but I'll try and limit my comments to a couple of areas. And the main point is that China is very, very schizophrenic when it comes to thinking about the currency, liberalisation, the dollar, etc. On the one hand, absolutely: China is hypersensitive to the possibility of sanctions. They've seen what's happened to Russia, in terms of the conflict, and relations are very bad with the US and the West. And there's a big move to try and ringfence Chinese economy and Chinese trade from dollar and financial shocks and sanctions that might come through. And so China, of course, is very actively pushing these bilateral trading arrangements and clearing balances and swap arrangements to use the Chinese renminbi in trade with key partners. You've seen this from Russia to Brazil to Bangladesh. China is actively trying to set up alternative arrangements to just make sure that key inputs into the economy, key goods and services, are insulated from potential dollar sanctions and financial sanctions that might be applied. And so in that sense, yes, you're starting to see a lot more marginal use of the renminbi and they're very active in pushing that out. On the other hand, and this is also very important, China has one of the most closed capital accounts of any country on the planet. It's extraordinarily difficult for locals to get just renminbi out of the system to convert to dollars. China has a massive liquidity and a huge financial pool of renminbi savings locked up onshore, and has been moving, if anything, in the last 10 years in the opposite direction. It's been tightening and tightening and tightening on capital controls at home to try and avoid this giant pool of liquidity from spilling out and overwhelming the currency and its reserves. And just to give a set of numbers here: the aggregate size of the Chinese banking system, in terms of total renminbi assets liabilities, adds up to about 60 trillion US dollars. That's the size of that onshore trade, and you're backed up by $3 trillion in reserves. Three trillion sounds like a lot, but relative to the size of monetary assets in the system it's actually very, very small on a relative basis. And so China on the one hand is very interested in putting these trading arrangements and clearing arrangements in place. Use the renminbi and invoicing and payment. On the other hand, it has no intention whatsoever of opening up the capital account and truly moving the renminbi to convertible investable currency – that would supplant the dollar. If anything, it's moving in the opposite direction today to try and make the renminbi less convertible and avoid capital outflows and shut doors and windows on capital transactions. So, just to summarise: yes, you're going to see more news flow and activity related to the renminbi, but we are not talking about something that's going to take over from the dollar in terms of its role in global portfolios, its role as a reserve currency, reserve assets, because the renminbi is a very, very closed currency and will remain so for a good while to come, as best we can tell.


Luke Bartholomew, 26:13

All right, well, I think that is an excellent place for us to end today. So, as ever, let me please remind you to subscribe to us on your preferred podcast platform. And then all that remains is for me to thank John and Bob for joining us today. An excellent insight. And thank you all for listening. So, thanks very much and speak again soon.


Disclaimer 26:46

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for information purposes only and should not be considered as an offer investment, recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of abrdn.  The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.