China to walk a fine economic line after posting second-quarter growth

Beijing is on track to meet its full-year growth target of 6% or more, but mounting risks lurk beneath the solid numbers.

Shoppers in Beijing. Monthly readings of industrial output, retail sales, fixed-asset investment and urban unemployment all met or topped expectations in June. Picture: Li Xiaonan

Despite a solid economic performance in the second quarter of the year, Chinese policy makers are expected to walk a fine line between supporting growth amid rising downside pressures and letting the economy run its course as they pivot to tackle longer-term challenges.

China said its economy expanded by 7.9% in the three months ending June compared with a year earlier. Monthly readings of industrial output, retail sales, fixed-asset investment and urban unemployment all met or topped expectations in June, keeping China on track to meet the official full-year growth target of 6% or more.

Averaging growth rates from the past two years to strip out pandemic-induced statistical distortions, China’s economy expanded by 5.5% in the second quarter – higher than the average 5% growth rate for the first quarter of the year, and drawing close to the pre-pandemic trend line.

But beneath the robust growth numbers lurk mounting risks for the economy, including an expected tapering off in global demand for Chinese goods, slower investment in manufacturing and real estate, and the threat of fresh Covid-19 outbreaks that could weigh on domestic consumption.

China’s economic rebound also remains unbalanced, with domestic demand languishing while factory production and exports propel the economy.

“There is no ‘obvious’ driver from the domestic economy to power growth ahead,” said Betty Wang, senior China economist at ANZ, though she added that exports could continue to buck predictions of a comedown even after more than a year of outperformance.

The question now is whether Beijing is comfortable with the economy on a slower growth trajectory.

At times, Chinese authorities have suggested that they are not too worried about a downshift, instead emphasising the importance of avoiding less-efficient investments designed to boost growth at any cost. With its recovery on a stable footing and far ahead of the rest of the world’s, some economists say Beijing sees a window of opportunity to tackle longer-term structural problems such as high debt, low productivity, demographic worries and climate change.

Yet Beijing could be forced to act if things deteriorate more quickly than expected. Last week, China’s central bank unleashed fresh liquidity to the financial system in large part to support small businesses, though it had earlier pledged to avoid making “a sharp turn” in monetary policy.

Just a few months earlier, China was the first major economy to pull back pandemic stimulus. Economists from ING and Natixis expect China’s central bank to unleash more stimulus in the form of another cut in the reserve requirement ratio for banks, following one announced last week.

China’s attempts to finetune its monetary policy suggest it remains torn over whether to shift decisively toward further easing or tightening, said Bruce Pang, head of macro and strategy research at China Renaissance Securities.

Wei He, a Beijing-based economist at research firm Gavekal Dragonomics, regards the new liquidity from the central bank last week as a clear easing signal, but also believes it’s unlikely that China will tweak its key policy rates in the short run. “The downward pressure is largely manageable,” he said.

The pace of any slowdown, though not unexpected and perhaps even welcomed by Beijing, is likely to be determined by several closely watched factors, including export demand, property-sector investment and consumer spending.

China’s export sector has been bolstered for months by buoyant Western consumer demand for Chinese-made laptops, yoga mats, bicycles and other goods. But the good times may not last, some economists warn, pointing to a looming shift in overseas spending patterns as Covid-era restrictions are lifted, tilting consumption toward in-person services and away from buying goods.

At least for now, China’s exports have been supported in part by accelerating demand from Europe and Japan, replacing some of the waning American demand, said Larry Hu, chief China economist at Macquarie Group. China’s exports accelerated growth in June, defying expectations of a slowdown.

Another key factor will be investment spending, particularly into manufacturing and China’s housing sector. A focus of Beijing’s longer-term attempts to rectify economic imbalances has been curbing fresh funding to real estate – a campaign that economists believe policy makers are committed to.

The property sector, which accounts for some 7% of China’s GDP, has played a major role in stabilising growth during previous slowdowns. But a further tightening of credit for real-estate developers could trigger more bond defaults in the second half of the year, analysts say.

“Beijing is determined to reduce reliance on the property sector,” said Ting Lu, chief China economist at Nomura. Soaring prices for raw material could dent investor interest in pouring more money into new-home construction and manufacturing, he said.

And then there is consumer spending, which for more than a year has consistently been the weakest piece of China’s pandemic rebound.

Economists have been debating for months whether consumption, which has shown signs of promise but has been battered by frequent Covid-19 outbreaks, can reach pre-Covid levels this year. Averaging growth rates from the past two years, retail-sales growth has languished at 4.9% in June, according to ANZ – a far cry from the 8% year-over-year growth rate before the pandemic hit.

An unstable job market for China’s lower-wage earners and higher property prices have prompted an increase in precautionary savings, which has hit overall spending, said Shen Jianguang, chief economist at JD Digits, the finance arm of e-commerce platform JD.com.

Even as the surveyed urban unemployment rate has dropped to 5% in June from 5.4% in January, the jobless rate for those aged 16 to 24 years old, including fresh college graduates, has moved in the opposite direction, climbing to 15.4% in June from 12.7% in January.

That is not to say that there isn’t a desire to spend more. Wei Zhigang, a 43-year-old sales manager at a midsize property developer in coastal Zhejiang province, said his income took a hit during the pandemic last year as sales dropped by nearly 50% from 2019 levels. Business has recovered more slowly than expected this year, he said.

As a result, Mr. Wei and his family, who used to travel to the U.S. at least once a year for holidays but are now stuck within China, have been taking fewer trips and instead saving more money.

“I’d prefer to travel abroad if I can,” he said. “The money you saved ends up depreciating over time unless you spend it now.”

Grace Zhu contributed to this article.

The Wall Street Journal