Approaching the end of the year, how to summarize China's economy this year is a problem. And, looking ahead to next year, where will China's economy go?
At the end of last week, the World Bank released its economic report for mid-December 2023. It made a comprehensive evaluation of the performance of China's economy in 2023, and put forward direct questions and suggestions for the development of China's economy next year. The following are the key takeaways from the report.
China's economic activity picked up in 2023, but the recovery remains fragile. Real GDP growth accelerated to 5.2 in the first three quarters of 2023, driven by service demand, resilient manufacturing investment, and public infrastructure stimulus2%。The initial phase of economic reopening triggered a surge in economic activity in the first quarter, but growth momentum decelerated rapidly in the second quarter before recovering modestly in the third quarter. The erratic growth performance, coupled with persistent deflationary pressures and still-weak consumer confidence, suggests that the recovery remains fragile.
Driven by pent-up demand for services after the pandemic, consumption is the main growth driver, while consumption of goods lags. The resilience of manufacturing and infrastructure investment offset the decline in real estate investment, which contributed positively to economic growth. At the same time, net exports contracted as weak external demand weighed on exports, while imports improved.
Still, recovery from the pandemic remains fragile. The initial phase of economic reopening triggered a surge in economic activity in the first quarter, but growth momentum decelerated to an annualized 2% in the second quarter before recovering to 53%。This erratic growth path suggests a persistent fragile recovery, reflecting short-term headwinds, including weak consumer confidence, a persistent downturn in the housing market, and weak exports, but also structural factors such as persistent economic imbalances.
The recovery in consumption has benefited from an improved labor market and the release of pent-up demand for services, but has been impacted by income growth and weak consumer confidence. While labor market conditions are improving, the unemployment rate has risen from a peak of 5 in February6% fell to 50%, back to pre-pandemic levels. From January to September, there was a net increase of 10.2 million in urban employment.
However, these job increases were largely driven by increased hiring in low-skilled service industries, but not in proportion to income growth. The wage growth rate for the first three quarters of 2023 is 68%, still below the pre-pandemic level of more than 8%. In addition, the wealth of some households has shrunk significantly as secondary market housing prices in lower-tier cities have shrunk by more than 10% from their peak in 2021**. These factors, combined with the time lag in translating labor market gains into improved sentiment, continue to weigh on consumer confidence and spending. Retail sales growth increased from a monthly average of 14% slowed to just 01%。Structural factors such as limited social protection and persistent inequality also discourage consumption.
Domestic investment grew at a slower pace compared to 2020-22, mainly due to the ongoing challenges facing the property sector. Real estate investment fell by 8 percent following last year, due to weak housing demand and debt distress for property developersAfter 4%, it fell by 7 in the first 10 months of 20238%。Investment in the upstream sector, which provides input to real estate, is also declining. In contrast, manufacturing investment remained resilient overall, particularly in the automotive, electrical and electronic machinery sectors, in part due to relatively strong demand and policy support. At the same time, infrastructure investment has been supported by policy support.
Despite policy easing, structural challenges remain, and housing demand in China remains sluggish. In the first 10 months of the year, the value of new real estate sales fell by 49%, sales decreased by 7 percent year-on-year8%。The decline was even more pronounced in Tier 2 and Tier 2 cities, which account for about 80% of China's property market, where house prices continued month-on-month**. Although demand-side easing measures such as lowering down payment ratios and lowering loan interest rates have been implemented, the market has not yet stabilized, indicating that these policies have not yet effectively solved the problem of sluggish housing demand. The weakness in demand is partly due to lingering uncertainty over the post-pandemic income outlook and concerns about housing delivery, but this is exacerbated by structural issues such as demographic change and slowing urbanization.
Slowing housing demand and high leverage for developers have masked near-term policy support. In the 10 months of this year, the number of real estate completions increased by nearly 20% year-on-year, thanks to more than 500 billion yuan of policy support for pre-sold unsalable projects. At the same time, developers continued to face financial pressure, with funds raised falling by more than 13% year-on-year. Much of this decline is attributable to developers' high debt distress and slowing housing demand, which has been further exacerbated by the loss of confidence among homebuyers to complete pre-sale homes on time. Real estate investment continued to shrink, with housing development investment and new housing starts falling by 9 per cent from January to October3% and 254%。
Amid a fragile and uneven recovery, consumer** inflation remains low. Headline inflation has barely increased since April 2023, compared to 20%。In July and October, for the first time in more than two years, it fell into deflationary territory. The decline was due to the fact that goods*** offset the strengthening of inflation in the services sector, reflecting a different trend in consumer demand. Weakness in the real estate sector has led to lower rental costs and home appliances**, while automakers are vying for market share while price cuts have added downward pressure. Excluding volatile food and energy**, core inflation hovered at 0 over the same periodAround 7%, which is continuously lower than the pre-epidemic level of 16% level.
Producer** deflation persisted, but has eased in recent months, driven by global commodities***. PPI inflation has been in deflationary territory for a year, largely due to persistently low domestic industrial demand. The long-term downturn in the real estate sector has led to weak demand, especially in upstream sectors such as metals, cement, and construction machinery. However, the recent trend in global energy** has moderated the contraction of domestic factory shipments**.
Merchandise exports continued to decline, reflecting weak external demand amid a shift in global demand from coatable commodities to other commodities. In the 10 months of 2023, exports of goods fell by 56%, compared to an increase of 111%。Exports across sectors and partners have deteriorated broadly, with exports to ASEAN countries and the EU being the most severe. Contractions were seen across all product groups, but the most severe contraction was in high-tech manufacturing. Compared to overall merchandise exports, automotive exports, including electric vehicles, have grown at double-digit rates since August 2020, and China*** continues to expand its global market share.
Imports of goods also continued to decline. In the first 10 months of 2023, imports contracted by 65%, compared to a 35%。Sluggish demand for processed imports in the export sector, sluggish domestic consumption of goods, and weak real estate investment led to a decline in overall imports.
Exports of services contracted, reflecting a decline in transport services, while imports of services increased due to the recovery of outbound tourism. In the first three quarters of 2023, exports of services contracted by 13 percent year-on-year5%, mainly due to continued declines in exports of financial services, inbound tourism and transport services, reflecting declines in exports of goods and freight**. In contrast, imports of services increased by 15 percent due to outbound travel following the resumption of international travel3%, but not yet at pre-pandemic levels.
In the first three quarters of 2023, the current account surplus fell and returned to pre-pandemic levels, while the resumption of outbound tourism pushed up the service deficit. With global demand for goods falling and outbound tourism picking up, the one-time growth in China's net exports during the pandemic has now waned. These measures pushed the net export surplus as a percentage of GDP from 3 in the same period of 20224% narrowed to 2. in the first three quarters of 20232%。Net income from abroad has improved, and the deficit as a percentage of GDP has increased from 11% to 06%。As a result, the current account surplus as a percentage of GDP increased from 2.2 in the first three quarters of last yearThe high of 3% fell to 16%。This reflects a gradual return to pre-pandemic levels of the current account surplus.
Financial and capital account deficits widened as a result of increased capital outflows and outward investment. Widening interest rate differentials with major countries, business uncertainty remains high, and geopolitical tensions have dampened foreign capital inflows into China. In the first three quarters of 2023, FDI inflows as a percentage of GDP increased from 11% down to 01%。After the reopening of the economy, FDI outflows also increased to 1 percent of GDP in the first three quarters1%。By contrast, non-FDI net outflows, including investments, derivatives and other investments, are expected to total just 0.0 percent of GDP in the first three quarters of 20234%。Overall, the financial and capital account deficit as a share of GDP increased from 1.0% in the first three quarters of 20223% rose to 1. in the first three quarters of 20234%。
Net capital outflows and a generally stronger US dollar continue to weigh on the RMB. Despite a strong current-account surplus, the renminbi depreciated by an average of 4 against the US dollar5%, but remained stable in the first 11 months of 2023 on a **weighted basis. At the same time, China's foreign exchange reserves fell slightly, but remained as high as 3$1 trillion.
Weak land leasing has limited local government spending. From January to October, the consolidated fiscal revenue increased by 2 percent year-on-year5%。This is despite a 10% year-on-year increase in tax revenues7%, but the comprehensive income growth was driven by a sharp decline of 20 in land leases in the previous 10 monthsThe impact of 5% has led to growing concerns about the debt sustainability of local** financing platforms. Weakness in land lease income, which is the main source of income from infrastructure financing**, continues to hamper local capital expenditures. From January to October, the consolidated fiscal expenditure decreased by 12%。Overall, fiscal policy is less accommodative compared to last year, with a consolidated fiscal deficit of 4.0% of GDP as of October5%, compared to 5. % of GDP in the same period in 20225%。
In response to persistent vulnerabilities, fiscal support has been stepped up and an increase in transfer payments has helped ease local financing constraints. China's legislature approved the issuance of 1 trillion yuan (0. % of GDP).8%)* special government bonds, which are used to support natural disaster recovery and disaster prevention and mitigation, effectively reducing the consolidated fiscal deficit target for this year from 6 percent of GDP4% to 72%。It is worth noting that ** will bear the responsibility of repaying the principal and interest of these bonds in full, thereby reducing the financial burden of the local **.
Since the beginning of this year, the People's Bank of China has continued to implement loose monetary policy, but there is limited room for further easing. In the context of low inflationary pressures, the main monetary policy rate is moderately lowered to support the economy. At the same time, the People's Bank of China (PBoC) has maintained abundant liquidity in the market. In early March, the People's Bank of China cut the reserve requirement ratio by 25 basis points, and in September it cut it by a further 25 basis points. Nonetheless, rising interest rates and capital outflow risks in other major economies could limit the scope for monetary easing. Since April 2022, the spread between China's 10-year Treasury yields and the corresponding US Treasury yields has been negative.
* Strong bond issuance led to credit growth. The year-on-year growth rate of non-financial sector credit has improved to 93%, although down from 95%。* A surge in bond issuance has been the main driver of credit growth in recent months. Conversely, the slowdown in corporate lending and corporate bond issuance reflects weaker credit demand, especially from property developers and local** financing vehicles. While lower rates on existing mortgages and lower down payments spurred a modest increase in credit demand, the expansion of long-term household lending still lagged behind historical trajectory. At the same time, China's non-financial sector debt-to-GDP ratio, including external borrowing, has risen to around 300% of GDP as credit growth has outpaced nominal GDP growth.
Real GDP growth is expected to recover to 52%, 04 percentage points. Although growth momentum is expected to stabilize in the near term, the short-term outlook is bleak due to the gradual recovery of consumer sentiment and policy stimulus, the continued weakness of the real estate sector and the continued tepid external demand. China's economic growth is expected to slow to 4.024 and 2025, respectively5% and 43%, reflecting both short-term headwinds and growing structural constraints to growth, including high debt levels, an aging population, and persistent economic imbalances.
Headline inflation is expected to rise modestly. Services inflation is expected to continue to rise as consumption continues to recover, with headline inflation expected to rise to 1 y/y5%, while food is expected to be driven by pork bottoming out and the high base effect weakening.
There will be considerable downside risks ahead. The housing market downturn is likely to last longer than expected, impacting consumer confidence and spending, and putting pressure on upstream traders and creditors. This will further squeeze local** revenues and dampen public investment. Externally, the economy is vulnerable to weaker global demand due to tightening financial conditions and heightened geopolitical tensions. Climate change and related extreme weather events have increased in frequency in recent decades, also posing downside risks. In contrast, stronger-than-expected policy support and further progress on structural reforms could pose upside risks.
China needs sustained policy support and deeper structural reforms to hedge downside risks to growth, contain deflationary pressures, and restore confidence. Given the severe fiscal constraints at the local level, transferring a greater proportion of stimulus financing to *** will expand the necessary fiscal space. The recently adopted budget amendments, which envisaged the use of national debt to finance natural disaster recovery and enhance disaster response capacity, are welcome developments. However, in order to solve the structural imbalance of local finance and effectively solve the debt problem of local financing platforms, it is also necessary to deepen the reform of the financial system. This should include corporate and financial restructuring of local** financing vehicles, for example through spin-offs, and possibly even divestments of purely commercial assets. Similarly, in the real estate sector, short-term regulatory easing and liquidity support need to be complemented by the development of a framework to address corporate debt overhang.
Against the backdrop of an aging population, rising precautionary savings, and a rebalancing of down payment distribution, the deceleration in China's investment has been one of the key drivers of the overall slowdown in recent years. While the growth rate of total investment has fallen, the investment structure has also undergone significant changes. The long-term downturn in real estate has led to a continuous sharp decline in real estate investment, with a cumulative decline of 18% in the past two years. In contrast, manufacturing investment, which is generally higher in returns, was more resilient, with a cumulative increase of 16% over the same period. The resilience of manufacturing investment is partly a response to surging demand for products such as electric vehicles, batteries and other low-carbon technologies, but also reflects growing support for priority manufacturing sectors such as semiconductors.
However, strong GDP growth in the medium term will require more than solid manufacturing investment, but also stronger consumption growth. Real estate investment is expected to remain subdued due to property developer balance sheet constraints and a prolonged decline in housing demand, so China's overall investment rate is likely to stabilize at pre-pandemic levels, even if manufacturing investment remains resilient. While the reduction in investment is part of a necessary adjustment in China's economy, consumption growth needs to accelerate to compensate for the slowdown in aggregate demand growth. Although the shift to manufacturing has brought short-term improvements in the efficiency of capital allocation, the rapid expansion of investment scale and increased state support may lead to overcapacity and inefficiency in some industries.
Structural reforms are essential to accelerate the rebalancing of higher consumption and reduce the risk of inefficient capital allocation. The renewed focus on implementing structural reforms, taking concrete steps to strengthen the rule of law, enforce regulations independently, promote competition and ensure a level playing field, following recent statements by policymakers, can help ensure that resources are allocated to the most productive sectors and firms. Deepening financial reform will enhance the marketization of financial intermediaries. Measures such as improving the progressiveness of the fiscal system, reforming the hukou system, and cultivating inclusive finance will support the growth of household consumption.