Chinese economic news has been disappointing of late. Unsurprisingly, Western media outlets have laid it on thick, with some 400,000 articles published in the past 3 weeks; 33,000 of which were explicitly negative — the highest ratio since 2015. While the data out of China has certainly not been encouraging of late, journalists have taken the opportunity to blend current issues in with yesteryear’s favourite fear mongering points. Debt bubble! Fabricated data! GHOST CITIES!!! 

Some of the hyperbole is attributable to a misunderstanding of China’s economic and political systems. However, with bipartisan support in the US for “tough on China” policies and rhetoric, it is no shock that the media would be quick to jump on the bandwagon. But what is really happening?

When the Chinese government abruptly lifted lockdown restrictions late last year, we expected an epic release of pent-up consumer demand. This was based on the observed outcomes of other nations’ re-openings and the fact that Chinese citizens spent a much longer period in confinement with rapidly accumulating excess savings. 

To date, this view has not yet materialized. Despite a brief spike, shell-shocked Chinese consumers have collectively padlocked their wallets and continued to accumulate deposits; with savings rates now well above already high (relative to global peers) historical levels. Per the chart below, retail sales have fallen below their pre-pandemic growth trend. 

The reasons for this conservatism generally stem from concerns about the economic outlook and household wealth. With weak industrial production and tight credit conditions, businesses have hunkered down and been reluctant to hire and boost compensation. The trend toward supply chain diversification out of China has further encouraged belt tightening in export-oriented sectors. Viewed in this context, it is understandable that Chinese employees concerned about their earnings prospects would decide to hoard cash. 

Like many other countries (and perhaps more so given cultural emphasis), Chinese households have a disproportionate amount of their net worth tied to real estate. Troubles in the property sector are nothing new. The credit tightening and housing speculation deterrent campaigns initiated prior to the pandemic brought developers to the brink of default. While policymakers have managed the fallout, the property sector has not been “bailed out” and real estate market woes continue. Accordingly, the negative wealth effect on Chinese household balance sheets has further eroded consumption appetites. 

What can be done to repair damaged consumer sentiment and avoid a deflationary spiral? More forceful monetary and fiscal stimulus is crucial. Policymaker timidity thus far can be attributed to a reluctance to undo the hard work in recent years to alleviate systemic imbalances. China is also attempting to maintain a “cross-cyclical” economic management strategy; avoiding wide swings in activity which characterized recent decades. But in a tug-of-war between policy imperatives and the economy, something has to give; and we have a very strong conviction that a deep economic contraction simply would not be tolerated. With expectations so low towards the Chinese economy, we are again at a point where “upside surprises” are highly likely in the coming months. This should benefit not only domestic assets but the wider emerging markets complex.