Tian Yong Woon

China watchers saw reason for some cautious optimism lately, as economic data for August showed signs of growth stabilization. Retail sales and industrial production expanded at a brisker pace, while trade registered reduced rates of decline. Growth in fixed asset investment, however, continued to slow. Additionally, China’s latest PMI readings for September were a mixed bag, as official readings indicated some pick up in non-manufacturing activity, while the Caixin gauge signaled slower growth in both manufacturing and services. Looking further back, China’s GDP growth in Q2 fell short of expectations, as a much-hyped post-pandemic rebound disappointed. Instead, the Q2 growth reading was supported by low base effects from a year ago, during which China enforced strict pandemic-related lockdowns. Regardless, China’s growth for the year has been predominantly consumption-led, while trade acted as a mild drag (chart 1).

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**China’s latent consumption boosters**
Looking ahead, household consumption in China may still have legs for further growth, especially if latent drivers are unleashed. For one, China still has much to recoup from the domestic tourism losses incurred during the pandemic as locals start to fully resume their inter-city holidays. Domestic urban tourism arrivals have already recovered in H1 this year to about 84% of pre-pandemic levels (H1 2019), with China’s Tourism Academy expecting domestic travel revenues to reach 80% of pre-pandemic levels in 2023. Another latent consumption driver lies in China’s swelling household deposits, which have surged by about 62% since the onset of the pandemic to reach values equivalent to nearly 110% of China’s nominal GDP for 2022.

With that said, and despite some anticipation of “revenge spending” wrought by a drawdown of elevated savings, China’s household deposits continued to grow with the reopening of the economy, albeit at modestly declined rates. The absence of a consumption revival led by reduced savings suggests that other factors – possibly those relating to dampened consumer and investment sentiment – may be at play.

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**Positive externalities from China’s recovery**
The potential benefits of a robust Chinese recovery are immense, with corresponding positive externalities likely to be reaped through numerous channels. For instance, Chinese tourists remain a largely-dormant well to be tapped upon for inbound revenue, given how their overseas travel activity have hitherto been sluggish amid lingering uncertainties at home. A stabilization of China’s domestic economic situation, coupled with some yuan recovery and an eventual easing of temporal travel-related frictions could coax more Chinese travelers into taking trips abroad. Tourism-reliant economies who have yet to experience a big Chinese tourism recovery – such as Thailand – would stand to benefit the most from this scenario.

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Tourism aside, Asia Pacific economies also stand to gain from renewed import demand from China, should the latter’s domestic situation recover sufficiently to rev up the consumption of foreign goods and services. Despite some gradual shifts seen over recent years, many Asia Pacific economies still bear significant export exposure to China (chart 4). Specifically, about 33% of Australia’s exports and about 28% of New Zealand’s are shipped to China, while Indonesia’s exposure has risen to about 25%, from just 9.2% in early-2015. In contrast, India has seen its export exposure to China gradually decline, to about 3.5% in July, from 6.8% in early-2021.

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**Persisting headwinds**
Barring the aforementioned supports to growth, China continues to grapple with a spate of near-term challenges, both domestically and overseas. Externally, China is suffering from a deteriorating trade surplus, which has been pulled down by diminishing imports from major trading partners such as the United States and the European Union. China is also reeling from a deterioration of its terms of trade, brought about in part by higher energy costs (chart 5). An additional – and more recent – sources of price pressure stems from food prices, as El Nino effects threaten crop yields globally. China is not alone, however, in its import price predicament, with other Asia Pacific economies, such as South Korea and Malaysia, facing a similar squeeze.

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Apart from trade-related matters, China faces added challenges from dwindling foreign direct investment (FDI) and persistent foreign portfolio outflows. This is indicative of the cautious outlook on the economy from external investors. Specifically, China’s rolling 4-quarter net FDI inflows have shrunk by more than 80% since end-2021, while corresponding portfolio flows have logged persistent net divestments since Q3 last year (chart 6). More recently, China’s non-banking sector suffered a capital flight of $48.9 billion in August – the largest monthly outflow since December 2015 – of which $16.8 billion were net FDI outflows and $29.4 billion were net portfolio divestments.

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Internally, China continues to confront persistent weakness in its real estate sector, with major property developers like Evergrande and Country Garden still struggling with debt and liquidity-related woes. Sentiment toward the sector has become increasingly negative since the onset of the property crisis in 2021, with investments into and sales of Chinese real estate turned increasingly subdued over the period. Zooming out, China also runs a real risk of a broader supply-side issue: it already has more homes than people to live in them.

Asia

Economic Letter from Asia: Some Perspectives on China

Investor sentiment has come under pressure following some messaging from the Fed last week to suggest that US interest rates could likely stay higher for longer. As expected, however, Asia’s central banks have held their policy rates steady over the past few days. Additionally, the Bank of Japan (BoJ) left its Yield Curve Control (YCC) parameters unchanged. Meanwhile, in China, banks retained 1-year and 5-year loan prime rates (LPRs) at 3.45% and 4.2%, respectively.

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**Japan 10-year yields and the yen**
While the BoJ’s July move to allow greater yield-targeting flexibility has kept challengers to the bank’s upper yield limit at bay so far, JGB yields have been climbing closer to their new implied upper limit of 1%, albeit in a less volatile manner than seen earlier this year. Japan’s 10-year yields have faced upward pressures of late, likely in anticipation of additional YCC tweaks ahead, and on speculation of imminent policy normalization by the central bank.

The yen has faced downward pressure, however, given Japan’s unfavorable yield differentials with other major economies. Against the dollar, the yen has weakened by more than 10% so far this year, as the 2-year yield differential between the US and Japan approached historically-wide levels (chart 2).

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**China’s policy easing moves**
China did not instigate any further monetary policy easing moves this week, as it kept its 1-year and 5-year LPRs unchanged. But this follows some broad steps to loosen monetary policy in recent weeks via cuts to its 7-day reverse repo rate, 1-year medium-term lending facility rate, and 1-year LPR in August. The required reserve ratio was additionally lowered for most banks in September. While China’s additional easing moves may come as good news, latest easing moves are still better-characterized as modest, with much uncertainty on growth still stemming from e.g. China’s floundering property sector.

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**Inflation risks lie ahead**
Resurgent inflation continues to present a real and present danger to most Asian economies, even after significantly-softer price pressures through most of this year. For one, energy prices, which helped drive down inflation in most Asian economies between mid-2022 and earlier this year, are likely to add upside pressures moving forward – barring domestically-enacted energy subsidies and price controls – given the recent surge in crude oil prices.

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Energy matters aside, Asian economies face an added inflation threat from food prices, particularly from that of rice. The latter stems in large part from the impact of India’s export ban. India froze exports of non-basmati white rice in July over concerns of poor harvests due to El Nino effects. Following the ban, the UN Food and Agriculture Organization logged a near-10% increase in its All Rice Price Index in August. For context, India is the world’s largest supplier of rice to the world, accounting for about 40% of global exports in 2022, while Asia is the world’s largest rice consumer, comprising over 90% of global demand.

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Apart from inflation risks stemming from food and energy prices, imported inflation – spurred by protracted bouts of domestic currency depreciation – poses a lingering threat to efforts by regional central banks to tackle inflation. Most Asian currencies underwent a renewed bout of weakness this year, clocking significant net year-to-date losses against the dollar. The exception is the Indonesian rupiah, which continues to net a positive (but diminishing) carry over the dollar, and the Indian rupee, which has been supported in part by strong capital inflows from foreign investors.

**Foreigner inflows to India**
Delving deeper, foreign institutional and portfolio investors have poured around a net $19 billion into India’s financial markets so far this year, lending support to the Indian rupee and to India’s FX reserves. The year’s substantial net inflows into India contrasts with net outflows of about $16 billion seen by the end of last year, with most of the year’s net inflows so far allocated to Indian equities, followed by debt instruments.

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Economic Letter from Asia: Some Food for Thought

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Tian Yong Woon

Publications by Tian Yong Woon

Economic Letter from Asia: Some Perspectives on China

Economic Letter from Asia: Some Food for Thought