The 9 Major Challenges That Threaten China’s Economy With Collapse.
Everyone sees China emerging as the big winner in the war between Ukraine and Russia, but it won't be smooth sailing.
In 2009, China was the first country to return to economic growth after the global financial crisis with a historic stimulus package. Similarly, during the Covid-19 pandemic, China was almost the only country in the world to record economic growth in 2020. With the Russian invasion of Ukraine, it appears that China will be able to absorb more and more Russian raw materials and position itself as an economic winner from this crisis.
In contrast, the US and Europe are suffering from distressing inflation, forcing their central banks to tighten monetary policy. In the U.S., interest rates could be raised to the point where the country could fall into stagflation similar to that of the 1970s. The only obstacle to this path is the Federal Reserve, which wants to allow a “soft landing” for the economy.
Nevertheless, if China seems well oriented to take advantage of the new world monetary order that is taking shape with the birth of a Bretton Woods III, everything will not go smoothly. Like the West, China faces a series of obvious and growing problems that could well put an abrupt end to its rise to the unofficial status of the world's leading superpower.
Here are the 9 major challenges facing China that could bring its economy to the brink of collapse.
1. China faces largest Covid-19 outbreak since Wuhan
China's “zero-covid” strategy is no match for the Omicron variant. Although the country has long succeeded in limiting the number and spread of infections by implementing "surgical" containment measures, massive testing and strict travel restrictions, Omicron is now spreading.
On the last day of last week, some 3,400 infections were detected nationwide, double the number of daily infections so far. Changchun, the largest city in Jilin province with a population of 9 million, quickly went into lockdown after 23 infections were found. A day later, the rest of the province had to quarantine itself as well.
Chinese cities with populations in the millions have often gone into lockdown during the pandemic, but this outbreak is taking a particularly heavy toll. Shanghai, for example, China's largest city with 26 million inhabitants and a key location for global maritime trade, is also under threat of containment. In Beijing and Chongqing too, more and more new cases of Covid-19 are appearing. Finally, on Monday, Shenzhen (population 17.5 million) was confined.
Shenzhen is China's technology mecca and is even known as the region's Silicon Valley. As a result, Foxconn, Apple's local chip supplier, had to halt production on Monday. The port of Shenzhen, a major shipping artery, will also be closed. It's yet another blow to global supply chains, but China's economy will likely also feel the lockdown of its most innovative city.
2. Chinese companies' shares are in free fall
The Hang Seng TECH index of the Hong Kong stock exchange has already suffered a blow due to the containment of Shenzhen. Last week, the index was down nearly five percent. Things have not been going well for the Hong Kong stock market for some time. In one year, the Hang Seng has lost nearly a third of its value:
The NASDAQ Golden Dragon China Index, a listing of Chinese stocks on Wall Street, has seen a staggering 66% drop in the space of a year. At this rate, in a few days, the index could be even lower than it was at the start of the credit crisis in 2008. And then there are the tragic stories of Alibaba and Didi, two companies that are under constant scrutiny by Chinese regulators and have been severely sanctioned. Alibaba's share price has fallen at least 70% since its peak in late 2020:
Last week, Alibaba's stock price was below the closing price on the day of its IPO. Didi, a Chinese cab app that dared to go public on Wall Street, suffered a 44% drop in the stock market in the first session last week.
3. Chinese bonds are on the verge of collapse
China's bond market is looking more and more like a junk bond market. Government bonds, which are closely linked to the real estate sector, are under severe pressure. This is because average yields in foreign markets have risen by 25%. This is detrimental to Chinese bonds.
Besides, the Chinese government bond market shows other worrying symptoms. The yield on 10-year government bonds reached 2.8%, its highest level of the year. Investors are concerned that this is the result of a growing capital outflow.
4. Foreign investors are dumping Chinese bonds in droves
Foreign investors are feverishly withdrawing from the Chinese government bond market. One group even sold at least $5.5 billion worth of Chinese bonds in February 2022. According to Bloomberg, this would be the largest monthly outflow on record and also the first reduction in market value since March 2021.
According to some theories, Russian investors are selling the most Chinese bonds. Due to Western sanctions, they would have less and less access to foreign assets through their central bank.
5. China's real estate sector continues to collapse
China's construction boom has been one of the main drivers of the country's explosive economic growth in recent decades. But the Chinese government began cracking down on excessive lending and derailed speculation in the property market a few years ago. As a result, some real estate titans are in deep trouble. Perhaps the most prominent of these is Evergrande, the real estate developer that has more than $300 billion in debt to pay off.
There are already at least 14 Chinese real estate companies that are threatened with bankruptcy. The Chinese government refuses to bail out these companies. Local governments are willing to lower mortgage rates and reauthorize more bank loans for real estate companies, but this does not seem to be stimulating real estate sales in China at the moment.
For example, residential property sales in China have fallen dramatically in the first two months of 2022. China Vanke, the country's second-largest real estate giant, has already seen its sales drop 44% this year. China Overseas Land, a state-owned real estate company, has even seen a 54% drop. Fears of an unstoppable implosion of China's real estate sector remain real.
6. Human rights violations in China now also affect the local economy
Norway's state-owned oil fund, which manages some $1.3 trillion in assets, sold its stake in Chinese sportswear brand Li Ning last week. The Norwegians are not amused that Li Ning may use forced Uighur labor to produce its clothing.
This makes many investors in China and abroad nervous about how large Western institutions might invest in Chinese stocks in the near future. The Norwegians' decision last week has already sent shockwaves through the Chinese stock markets. The CSI 300 index, a Chinese stock index of the 300 largest stocks traded on the Shanghai and Shenzhen stock exchanges, recorded its biggest loss since March 2020.
If Western investors do indeed begin to take China's human rights abuses in Xinjiang and Hong Kong seriously, it could well be the death knell for the Chinese economy.
7. Chinese loans are collapsing
Chinese credit figures for February 2022 were much weaker than expected after the country's mortgage lending contracted for the first time in 15 years. After a record-breaking year, credit expansion slowed in February due to the long Chinese New Year vacation and a decline in the number of loans taken out due to the real estate market collapse described earlier. Banks only lent 1.2 trillion yuan in February, down from 4 trillion yuan in January.
All this suggests that companies are becoming more reluctant to borrow and invest. There is a lack of growth stimulation, and demand from the real economy is weak. The Chinese central bank will have to cut interest rates sooner than expected, according to the forecasts of several China analysts.
8. China doubles the fluctuation band of the yuan against the Russian ruble
People's Bank of China recently announced that it would double the exchange rate between the yuan and the ruble. According to Bloomberg, the two currencies could now trade at about 10% of the fixed exchange rate. This decision was made to meet the “market development demand” between the two countries, according to the Chinese foreign trade system. Previously, the limit of this fixing rate was about 5%.
This volatility introduced in the currency market may well lead to a decrease in interest in trading the Chinese and Russian currencies. The Russian ruble has collapsed as a result of a series of ruthless Western sanctions. A Chinese currency that is increasingly tied to a weak ruble will also become less attractive.
Total bilateral trade between Russia and China has been estimated at some $112 billion in 2020. However, Xi Jinping and Vladimir Putin signed a series of agreements last month to seriously increase Russian supplies of gas, oil and wheat.
9. China's GDP may soon decline
The indicators described above, namely weakening consumption in Chinese markets and ongoing supply chain problems, coupled with the Covid-19 outbreak, may well lead to a decline in Chinese GDP in the first quarter of this year.
Investment bank Morgan Stanley is already forecasting zero growth in China's GDP. According to the US bank, the economic costs of the zero-covid policy will increasingly outweigh the benefits.
Final Thoughts
People's Bank of China may soon be forced to loosen monetary policy to ease the country's growing economic problems. Meanwhile, the U.S. is going in the opposite direction and raising interest rates. The monetary policies of the U.S. and China will therefore diverge. The consequences of this divergence are not yet entirely clear.
Meanwhile, the Chinese central bank has adjusted its economic growth target for this year to 5.5%. According to several economists, however, this figure is unattainable. Only a massive financial stimulus could now save China from a painful recession. Even Chinese Premier Li Keqiang said at his annual press conference that it will be difficult to achieve this growth rate. It is perhaps no coincidence that Li also announced at the same press conference that 2022 would be his last year as Chinese Premier.
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