For more than three decades, the world economy has become accustomed to China being the main contributor to global growth. In particular, during the 2008 crisis, the Chinese economy contributed up to a third of global growth, while the US economy collapsed, as did the European Union due to its sovereign debt crisis.
That memory of China saving international markets has long passed. China’s economy started to slow down after experiencing peak growth in 2010 and even faster after 2015, due to excess supply, deflationary pressures and the collapse of the overall stock market. As China’s economy started to recover in 2016, Trump came to power in the U.S. and, with him, the trade war further slowed down China’s growth. Finally, the Covid pandemic and three years of zero-Covid policies weakened the Chinese economy even further, up to until the end of 2022.
Against this backdrop, 2023 was expected to be a wonderful year for the Chinese economy, as all mobility restrictions were lifted by the end of 2022. However, this has not been the case. In late 2022 high inflation in the rest of the world, fueled by high energy and food prices, had pushed central banks around the entire world to act aggressively, reaching interest levels not seen in decades. Such high interest rates were expected to have brought the U.S. and European economies to their knees, once again accelerating the convergence of growth between China and the West, as happened in 2008. This very favorable outlook for the Chinese economy led to strong capital inflows in the last few weeks of 2022 but only lasted until March, when activity data began to show that neither China’s consumption nor investment were recovering as expected.
A key problem has been the lack of confidence of Chinese consumers and investors despite having emerged from the pandemic. On the consumer side, households have faced stagnating disposable income and very high youth unemployment. As for investors, they simply do not believe that demand will be there to justify their investment, especially in the real estate sector. As if this were not enough, even exports have begun to slow down very quickly, reaching negative double-digit growth in June and July. This is clearly worrying, as a lack of external demand has been a major contributor during most of the Covid pandemic and even into early 2023. The reason for this change of direction in Chinese exports is attributed by some to the weakness of the North American and European economies, but the reality is that Chinese exports into Southeast Asia, a region which is still growing fast, fell as much as Chinese exports to Europe (both -20% in July).
The heavy burden of Chinese public debt, especially that of local governments, and the persisting situation of real estate developers, have pushed the People's Bank of China to increase the liquidity in the system by cutting the reserve requirement ratio and to reduce interest rates. Both, together with the now negative portfolio flows into China, have weakened the yuan. Investors are waiting for China to announce a big fiscal stimulus, but it does not seem likely to come. By now, the worries are not only about growth and/or deflation but also about the systemic risk embedded in a deflating real estate bubble, especially for the financial sector.
A key question is how much the rest of the world, which has long benefited from China's huge contribution to global growth, will suffer from its structural slowdown. If only for symmetry, one would tend to think that the global economy will suffer greatly, as the reserve happened in 2008 when China lifted global growth thanks to a massive stimulus. Instead, all signs to date suggest that China's economy is far more isolated from the rest of the world than one might imagine, even though it is much larger now than it was in 2008. The reason for China’s smaller influence, at least so far, might be related to China’s self-reliance policies. By substituting imports for domestic production, China has been cutting imports for almost a decade, especially for industrial goods. This means that many exporters, especially those of industrial goods such as Germany, Korea or Japan, have become accustomed to the reality of a weaker demand from China for their products.
Beyond these exporters of industrial products, the region that should be suffering the most from China's slowdown, given its trade integration, is Southeast Asia, but this does not seem to have been the case. In fact, in 2022 developing Asian countries achieved record levels of growth despite the fact that China grew only 3%, in the same year, dragged by its zero Covid policy. The growth gap between developing Asian countries– led by India and ASEAN countries– and China will moderate in 2023 but will remain open. This is good news for the rest of the world because it means that developing Asian economies as a whole are an increasingly important growth engine globally. In short, for the remainder of 2023 we must get used to China no longer being the main contributor to global growth. The positive, however, is that the rest of the world has become accustomed to China's structural slowdown, allowing more room for developing Asian economies to shine through and buoy global growth.