China's economy is recovering but unevenly

The Chinese economy is expanding at a faster pace than previously expected, suggesting the country is on track to meet its full-year growth target of around 5 percent, according to newly released data from the National Bureau of Statistics of China. China’s GDP in the first quarter of 2023 expanded 4.5 percent over the same period in 2022, higher than previous forecasts. Reuters, for example, forecast a 4.0 percent growth in the first quarter based on its surveys of 70 economists. A close examination of the data, however, suggests that this recovery is unbalanced and still faces many challenges, including weak domestic and external demand and a continuing lack of private sector confidence. Chinese officials are reassuring entrepreneurs of their support, but statements alone will not restore market confidence. Tangible government actions in support of private enterprises are needed to revive domestic private investment.

An uneven recovery

After China’s zero-tolerance lockdowns, quarantines, and other restrictions were rescinded, the Covid-19 virus spread rapidly through China between December 2022 and January 2023, raising doubts about when people would be able to return to normal personal mobility. In the first quarter of this year, services recovered relatively quickly as mobility rebounded. Value added in services grew 5.4 percent in the first quarter of 2023 in year-over-year terms, while that in secondary industries, including mining, manufacturing, public utility, and construction, grew only 3.3 percent.

The recovery in services gained momentum during the first quarter. Retail sales in January and February combined grew 3.5 percent year over year. This pace accelerated in March with a strong 10.6 percent year-over-year increase, resulting in a 5.8 percent year-over-year growth in retail sales in the first quarter. Restaurants, jewelry, and medicines saw the strongest growth. Value added in the accommodation and catering sectors recorded a nearly 14 percent year-over-year increase in the first quarter, the highest among all service sectors, reflecting a fast recovery in domestic tourism.

Despite the surge in these activities, consumer inflation remains subdued with the consumer price index in March rising merely 0.7 percent year over year, well below the government’s full-year target of around 3 percent, suggesting that domestic demand remains weak. Household savings in the first quarter grew at a faster pace relative to last year, reflecting continued uncertainty about income and jobs.

The pace of recovery in industrial sectors is more mixed. Industrial value added in the first quarter was 3 percent higher than the same period last year. In month-to-month terms, industrial value added in February and March stayed basically unchanged, suggesting that recovery has stagnated. Caixin’s Purchasing Manufacturers’ Index (PMI) also indicates that the momentum of recovery slowed in March with a PMI of 50.[1] The producer price index dropped 2.5 percent in March year over year, the biggest decline since June 2020. Industrial profits dropped by a surprising 23 percent through February year over year, the largest drop since early 2020.[2]

Despite signs of a recovery in exports in March, Chinese manufacturers continue to face weak external demand. Slowing growth throughout the world, especially in the United States and Europe, contributed to a drop in January and February’s merchandise exports of 6.8 percent year over year. Exports recovered strongly in March and grew 14.8 percent, largely thanks to strong electric vehicle sales and exports to Russia. Exports measured in dollars expanded in the first quarter by 0.5 percent compared with the same period last year, but exports by foreign manufacturers declined by 16.3 percent in the first quarter, raising concerns that foreign firms may be accelerating their supply chain relocation away from China.

But the strong growth in exports may not be sustained for the rest of 2023. The sub-indexes for output and total new orders for Chinese goods in Caixin’s PMI index declined in March, although it remains in expansionary territory. The sub-index for manufacturing employment shows layoffs among Chinese manufacturers were on the rise in March. Exports will therefore likely weaken in the second half of the year, even though exports in April may grow given the low base last year.

Property slump is easing

In the property sector, there are signs that the property slump is now easing. Property investment and sales through the first quarter were still in negative territory but by much smaller amounts than last year. New home sales by the 100 largest real estate developers in March expanded by nearly 30 percent year over year. On housing prices, there continues to be a divergence between top-tier cities and lower-tier cities. In year-over-year terms, housing prices in first-tier cities continued to increase in March, while those in second- and third-tier cities continued to drop, but by smaller amounts than in previous months. The government’s rescue plan appears to be starting to work. China’s reopening from the zero-Covid policy also provides a more favorable environment for housing demand to recover. Most likely property will be less of a drag on growth in 2023 than in 2022.

Private investment remains weak

Following pandemic lockdowns and regulatory crackdowns, the confidence of private entrepreneurs remains depressed. Private investment has stalled over the past five quarters while state-led investment has surged. Despite China’s reopening from its draconian Covid policy, the gap between the pace of private and state-led fixed asset investment remains wide through the first quarter of 2023. State-led investment expanded by 10 percent year over year through March, while private-led investment expanded by a mere 0.6 percent. Weakness in private sector activity is at least partly to blame for the renewed surge in the youth unemployment rate, which hit 19.6 percent in March. Given that a record number of 11.6 million college graduates will enter the labor market this year, revitalizing the private sector will be critical to providing enough jobs for them.

The Chinese leadership has tried to restore confidence in the private sector, but the government’s reassurances to entrepreneurs have not been sufficient to raise animal spirits. At the Two Sessions, China’s annual parliamentary meetings, in early March, the president told China’s political elites that private enterprises and private entrepreneurs are “our own people.” The new premier, Li Qiang, also sought to reassure the private sector by visiting multiple private firms in Hunan and Guangdong in his first trip as premier. The provincial government in Hainan recently issued a statement claiming that it will not arrest, detain, prosecute, or jail private entrepreneurs “unnecessarily,” triggering even more worries among entrepreneurs that the Chinese state may arbitrarily arrest individuals. These statements alone will not restore confidence of the private sector. Actions, such as reducing the role of the party-state in the economy, will speak louder than words.

Notes

1. A PMI reading above 50 indicates expansion, while a reading below 50 shows contraction.

2. Industrial profits reported by the Chinese statistical authority include only those with an annual revenue over 20 million yuan. Industrial profits data for March 2023 had not been released at the time of writing.