The much-heralded China economic reopening doesn’t seem to have materialised in the way markets anticipated. At various points during Covid, the prospect of China reopening for business post covid sent markets rallying higher on the expectation of higher demand driving the global economy. But so far, the reality has been underwhelming and it appears there are more economic challenges ahead for China than many anticipated.
Yesterday’s inflation figures for China show the once-powerful engine of global economic growth to now be heading for deflation. The CPI rate of -0.3% for the period was lower than expected and the flow-on effects are massive. Lower inflation and the prospects of lower economic growth are genuinely problematic for a nation that has been all about growth for the past 30 years.
In the past, China has had many long-term trends playing into their favour driving their growth. But suddenly there are a number of these trends are being reversed and we are now starting to see these factors impacting the country negatively. China has been the biggest beneficiary of globalisation over the past 20–30 years. Combining that with a huge population and rapid urbanisation sparked decades of investment that turned China into the world’s second-biggest economy.
Yet what China faces now is a totally different situation, and I am not sure the world has really considered what all of these variables combined really mean. All these issues are well known but China has been such an economic juggernaut it’s difficult for people to look at the situation with fresh eyes and consider what all these issues converging really mean for China and the world.
The catalyst for changing these trends was Russia’s invasion of Ukraine effectively waking the world up to the economic consequences of a conflict on the global supply chain. National security became the number one issue for every nation in the world and overnight it commenced the slow reversal of globalisation. As countries extricate themselves and their supply chain dependency from China this new trend will weigh on the Chinese economy as decades of investment is slowly unwound.
Meanwhile, emerging economies such as Mexico, India and Vietnam are booming as the USA and other Western nations are reshoring their supply chains and manufacturing. Make no mistake the process of untangling the global supply chain is still underway. The global supply chain dependence on China is a bigger vulnerability for the Western world than Germany’s dependence on Russian energy. There is no quick fix so all sides are working as quickly as they can to mitigate their risk. That’s a problem for China’s long-term economic growth.
Another overarching theme is their changing demographics. China’s population is aging and by 2035 an estimated 400m people will be over 60. Population won’t be the driver of growth it once was. But the trend that really accelerated the Nation’s growth over the last 20–30 years was the urbanisation of China. As people moved from the country to the city there was massive investment in infrastructure and property. Entire cities were seemingly built overnight. But simply developing infrastructure and buildings isn’t sustainable, in fact, it might be part of the current problem.
China is now at a crossroads.
The spectre of large amounts of debt has hobbled the economy. Economic growth has been lower than expected and in the past that was the signal for stimulus from the government. More often than not in the form of infrastructure and property development. It’s unlikely to be the case this time around and those past actions are part of the problem. Large debts at all levels of government, especially local government, were used to build projects that didn’t necessarily stack up financially. There are large amounts of infrastructure and property development that provided economic stimulus and jobs at the time but sit vacant or barely used now they are completed.
This is a serious problem.
It means that many of these projects haven’t delivered the returns needed to pay for themselves. But more importantly, faced with slowing growth, it may stop the government from being able to roll out the old playbook because they have effectively over saturated the market. The property and debt issue in China has been lurking since the collapse of Evergrande back in late 2021 and there remain serious problems and questions with regards to the entire sector. I am sure grand announcements of government stimulus and investment packages are coming but China need a new strategy to reignite growth.
By way of investing in Chinese equities, I still believe the country remains uninvestable. As I’ve previously said in these notes before, regardless of how big the opportunity may seem I am not interested in investing funds where a country’s government can torpedo entire companies or even industries overnight on a whim. Business is difficult enough at the best of times and I have no interest in the space and wish those brave, naïve, greedy or silly enough to invest there good luck.
With all of these long-term trends reversing, it will be extremely difficult for China to grow in the same way they have for the past few decades as they go forward. It’s time for investors to think carefully about what these changes mean and reevaluate what the flow-on effects are not just for China but more importantly for the companies in your investment portfolio that are heavily exposed to China. Australia has benefited enormously from the growth of China but if the Chinese economy faces a genuine slowdown and they are unable to resort to their usual ‘just build more playbook’ in the same way they have in the past there are huge implications for Australian companies of all sizes.
General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.