China Recession

Recession, not crisis

The press repeatedly reports on a real estate, economic or even financial crisis in China. Bankruptcies of real estate companies and high youth unemployment are often cited as anecdotal evidence of ‘the crisis’. A look at the data reveals a more nuanced picture: the construction sector is indeed in crisis and the Chinese economy is suffering from its collapse. Added to this are shrinking exports and weakening consumption, meaning that China is at risk of sliding back into recession in the coming quarters. However, in our view, the typical triggers for a major and potentially devastating banking or financial crisis are not present.

China is the world's second-largest economy and, according to the International Monetary Fund (IMF), accounts for one-third of global economic growth. If such a large economy were to slide into crisis, it would have significant consequences for the global economy. Is China really in crisis?

What is a crisis?

Today, complex situations are quickly declared crises. According to our definition, a crisis is accompanied by severe turmoil on the financial markets. Equities and risky bonds lose value and – particularly in emerging markets – currencies go into free fall. This is not the case in China today. The prices of equities and bonds listed in China have been moving sideways since the beginning of the year. The renminbi, the Chinese currency, has lost just under 10% against the Swiss franc since the beginning of the year. However, the Swiss franc is one of the strongest currencies in the world this year. The Japanese yen, Norwegian krone and New Zealand dollar have lost more value against the Swiss franc than the renminbi. Even on the Chinese property market – at the heart of China's economic malaise – prices are hardly falling.

China has a growth problem

The recovery effects that followed the end of the zero-Covid policy in December 2022 and still resulted in a growth rate of 2.2% quarter-on-quarter in the first quarter have evaporated. According to official data, the economy grew by only 0.8% in the second quarter. Monthly statistics from the retail and industrial sectors for the third quarter paint a picture of continued weakness. Consumption of goods is stagnating and retail sales are barely growing. Industry is suffering from weak export demand. Global trade is declining and the outlook remains poor. The Chinese construction sector is particularly weak, suffering from a slump in demand for real estate. The area of construction starts is 25% lower than last year and even more than 50% lower than in 2019.

Why China is not ‘falling apart’

Every crisis is different. Nevertheless, some commonalities can be derived from history. Below, we summarise the most important factors and explain the current situation in China.

1. China has no financing problem

Typical emerging market problems such as heavy dependence on foreign sources of financing, high foreign debt and a large trade and current account deficit are nowhere to be found in China. China has a balanced balance of payments, and the high trade surpluses of recent years have allowed China to act as a creditor internationally. No country has exported more capital than China in the last 10 years. In addition, Chinese savers also finance companies and the state domestically. So if foreign capital were to stop flowing into China, it would not be a problem for the Chinese state, the banks or the private sector.

2. China has no currency problem

According to our calculations, the renminbi, China's currency, is fairly valued. The central bank intervenes, but not to any great extent. The central bank's foreign exchange reserves – the ammunition for foreign exchange interventions – are stable. This is ensured not only by a balanced balance of payments, but also by strict capital controls. Chinese citizens cannot simply withdraw their money across borders, and hedge funds cannot bet against the renminbi (domestically).

3. China is not experiencing a banking crisis

A banking crisis is typically accompanied by at least one of the following factors: rising interbank interest rates (banks no longer trust each other) bank runs (customers no longer trust the banks) sharp increase in bad loans on bank balance sheets (customers no longer repay their loans) Banks incur large losses and thus lose equity capital. The current data does not indicate any of these problems. The interbank market is calm and bank deposits are rising steadily, as in previous years. In the second quarter, banks reported less than 1% bad loans and sustained profits. Chinese banks finance themselves mainly through bank deposits and earn good returns on them. These profits can also be used to finance the sharp increase in provisions for future loan defaults. If stress arises in the interbank market or a bank faces a liquidity crisis, the central bank is also ready to step in.

4. China does not have an inflation problem

On the contrary, due to the very weak economy, China has more of a deflation problem than an inflation problem. The central bank therefore does not need to raise interest rates and can continue to provide the financial system with generous liquidity if necessary – a privilege that central banks in Western industrialised countries have lost due to the rise in inflation over the last two years.

5. China does not have a heavily indebted government.

High government debt is a classic stumbling block for many emerging and developing countries (Argentina, Brazil, Ecuador, Zambia). China's government debt is estimated by the International Monetary Fund (IMF) at around 50% of GDP (2022). The OECD average is 89%. The Chinese government could therefore afford economic stimulus programmes and, if necessary, a recapitalisation of the banks.

Conclusion

China's GDP growth rate is likely to trend towards 0% in the coming quarters, which is lower than economists currently expect. Although this does not necessarily qualify as a recession according to the standard definition, it will feel like one given China's trend growth rate of around 5% (annual growth).

This is not good news for commodity producers. Global producers of machinery and capital goods are also likely to face difficulties in China in the near future.

However, we do not currently see any conditions that would cause this recession to lead to a financial crisis in China (or even worldwide).

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This publication is available only in German.