Self-sustaining economic momentum can only return once the property sector stabilises and consumers are confident enough to return to pre-pandemic levels of savings and spending. These pre-conditions for the malaise to end are still not operating with sufficient strength. With dollops of state support, economic growth can hover at around, or just below, the 5% pace which the authorities appear to want — so there is no crisis on the horizon.
China’s undoubtedly impressive progress in new technologies will also help — but only to some extent, as the weight of these new industries in total economic output is still too small. China is thus likely to endure one or two more years of challenging economic times.
Property sector recovery needed but not imminent
The first requirement for a self-sustaining recovery is for the property market to stabilise. That means that home prices should enjoy at least stability or small price increases for several months while housing starts and home sales need to be better aligned with each other, so that the inventory of unsold homes starts to fall. Despite some signs of tepid improvement, these conditions are not yet present:
Residential property prices have continued to decline even if the acute phase of the price slump is over. Among the four Tier 1 cities of Beijing, Shenzhen, Guangzhou and Shanghai, only Shanghai has experienced the strong demand needed for modest, sustained price rises. In the other three mega-cities, a nascent bottoming out in prices in the second half of 2024 gave way to renewed price declines in the past few months. Similarly, among Tier 2 and Tier 3 cities, only Hangzhou has reached some degree of stabilisation due to its proximity to Shanghai; price falls persist in the others. The sharper drop in second-hand prices also reflects distress-driven selling, reinforcing buyer caution.
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There is more hopeful news in terms of the inventory of unsold homes. New housing starts are now falling at a faster pace than the decline in home sales, implying that the inventory clearance process is underway. Developers are pulling back on new supply to avoid worsening the supply glut. The trouble is that this adjustment is too gradual given the massive outstanding stocks of unsold homes.
Low confidence among citizens
Fundamentally, it appears that ordinary folks still lack the confidence to snap up bargains in the housing sector. Perhaps they expect further price declines or they are worried about uncertain income prospects given the state of the economy. Lacking confidence in a full recovery, households are expanding their savings at nearly double the rate of underlying income. The signs are not encouraging for an improvement in this cautious mindset:
Consumer confidence remains depressed at Covid-19 era levels. Households had allocated too much of their savings for old age and healthcare to property, so the plunge in housing prices is forcing them to save more to rebuild the wealth that has been destroyed. This comes up in the People’s Bank of China’s Urban Depositors’ Survey. More than six out of 10 respondents are still prioritising accumulating savings deposits. That suggests that there is some way to go before they feel that they have achieved the savings level needed for their retirement.
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Consumers are conscious of downside risks to the economy, which make them worry about their jobs and incomes. Most Chinese are also aware that the US is targeting China in particular in its trade war, which could undermine an important engine for job creation. Rising youth unemployment is visible in the form of young graduates not securing work after graduation.
The downbeat sentiment prevalent among Chinese residents is grounded in structural factors, such as concerns over population ageing and the lack of a social safety net to absorb emergency expenses, causing households to target a higher level of precautionary savings. However, psycho-social trends such as tangping (lying flat, not working hard) also suggest less willingness to take risks with household finances via increased spending.
Structural challenges
Other imbalances need to be unwound, but they are difficult to resolve:
Persistent industrial over-capacity: As investment in property development and construction declined, the economy now depends on capital formation in the industrial sector to maintain growth. The government, in particular, favours channelling investment into “new productive forces” growth areas such as advanced manufacturing. However, China’s domestic demand deficiency has meant that much of this output has to be exported. This has triggered reactions not just from advanced economies, but also from emerging economies that have imposed anti-dumping measures against China to protect their industries. And that raises questions as to how sustainable this strategy will be.
Unbalanced public finances also need to be resolved: There is a basic mismatch between the spending obligations of local governments and their capacity to raise revenues. This has led to local governments relying excessively on land-related revenues. Thus, when the property sector slumps, public spending is curtailed for want of funding, amplifying the effects of the slowdown. Since the central government is well-funded, reforms are needed to shift revenues from the centre to the localities. But there appears to be reluctance at the top level to pursue this route.
The financial architecture is also a barrier towards the necessary rebalancing: The financial system is characterised by asset-heavy, state-owned financial institutions and top-down regulation of interest rates and capital flows that do not allow the market to function effectively. Capital controls also limit household access to higher-yield investment options, contributing to the dominance of housing as a savings vehicle and crowding out more diversified household asset portfolios that may be more conducive to consumption.
Potential bright spots
The government has held back on large-scale stimulus on the view that the economy needed to go through an adjustment, even if that adjustment created pain. This was to ensure that excesses such as over-investment in property and local government over-borrowing could be expunged from the economy. As it showed with the aggressive subsidies for consumers to replace their household appliances and vehicles, government programmes can help boost demand significantly.
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We expect the meeting of the senior political leadership slated for end-July will give the go-ahead for another round of policy support measures. This will probably take the form of more subsidies for consumers and some degree of monetary easing. Our guess is that enough will be done to keep economic growth at around 4% to 5%.
The longer-term strategy appears to be to seed enough new, high-value and high-growth industries so that China shifts to a new development path that is higher-quality and more sustainable. China’s startling advances in a range of industries give its leaders confidence that this strategy will work.
China’s prowess in the industries of the future such as electric vehicles, battery technology, solar cells, robotics, drones, and high-speed rail are already well known and are resulting in Chinese companies growing into world champions while China’s exports to the rest of the world are now increasingly dominated by such high-technology products rather than labour-intensive garments, shoes and toys.
There is evidence to suggest that there will be more areas where China will demonstrate technological leaps. One example is in the biomedical area. The data shows that China has emerged as a global powerhouse in biotech research, and this will lead to advances in many related areas.
For example, China held the record for the most-cited papers in 2023 in areas as diverse as synthetic biology, genomic sequencing and analysis, novel antibiotics and antivirals, and biological manufacturing. In 2024, more than 1,250 innovative drugs entered development in China — a figure that exceeded that of the European Union and is not far from what the US has.
Another area where China is surprising analysts with the speed of its progress is in defence technology. Chinese defence equipment appears to have played a major role in the recent clash between India and Pakistan, reportedly enabling Pakistan to shoot down Indian fighter jets at least in the early days of the conflict. China is said to be making rapid progress in areas such as hypersonic missiles, next-generation stealth aircraft such as the J-35 stealth fighter and the H-20 stealth bomber, which could challenge America’s longstanding air superiority.
The key point here is that defence technology usually has powerful spillover effects into the rest of the economy, helping to nurture advances in technology for civilian uses as well. Also, it takes the creation of a powerful scientific research and manufacturing ecosystem for success in defence technology — that same ecosystem can help fuel even more progress in adjacent areas for civilian use.
The question is whether these new growth engines will be enough to help turn around the economy. For now, this is not the case. In the first six months of this year, overall fixed-asset investment grew 2.8% compared to the same period the year before – that is a deceleration from 3.7% in the January-May period. In other words, even the creditable manufacturing investment expansion of 7.5% that was boosted by rapid growth in high-tech investment was not sufficient to offset the 11.2% plunge in real estate investment.
In short, the new industries still do not carry enough weight in the overall economy to turn it around the economy.
Where does this leave China?
Some important conclusions arise from this discussion. First, the short-term economic outlook will not be easy for China. Policy making is tricky when there are deep structural issues in the economy that complicate the outlook.
The authorities are aware that the short-term need to support growth could conflict with the longer-term need to cleanse the economy of the imbalances that have built up. Getting the balance right is therefore not easy and policy errors could result. The risks are real and very clear.
In addition, the perception that China’s economy is weak could embolden the US to press China very hard on trade concessions, in the belief that China cannot afford to risk a trade-related slowdown that would ensue if the US imposed harsh tariffs on China. This is an added reason why we believe that the July leadership meeting in China will result in strong support measures.
Second, however, it is important to recognise that China is never a black or white story. Despite the undoubted near-term travails, China has put in place a complex ecosystem that can produce far more rapid technological advances in the industries of the future than its detractors had expected.
That ecosystem is helping China gain extraordinary export competitiveness — and that same ecosystem may even help Chinese companies adjust to tariff levels as high as 35% that the US might choose to impose on China.
Difficulties lie ahead for China, but if it can avoid policy errors, it is likely to emerge stronger in the end.
Manu Bhaskaran is CEO of Centennial Asia Advisors
