The Chinese-style modernization

The Central Committee of the Communist Party of China (CPC) said the Chinese economy remains on course towards “modernization” as it pledged to further open up to global markets while pursuing domestic policy reforms to sustain growth.

The CPC held in July its third plenary session to chart economic strategies in the next five years, which revolved around the theme of further deepening reforms. The priorities are science and innovation, infrastructure, and technology; as well as addressing disparities between national and local government finance and enhancing the digital economy. These are the sectors of the future that will allow the Chinese economy to grow sustainably in the long run, coupled with its thrust of embracing more market-oriented strategies in price setting and trade.

However, there is little discussion on how the CPC will address the property sector crisis head on, which is the root cause of China’s prolonged stock market slump, depressed consumer and business confidence, and soft GDP expansion. A handful of risks threaten the country’s quest to become a “high-standard” socialist market economy in the face of a renewed tariff war waged by the US,Europe, and Canada against China-made goods, particularly electric vehicles (EVs).

Stoking consumer demand

As expected, the CPC’s third plenum provided broad strokes regarding the direction of the Chinese economy. Days later, the Politburo followed up with a pledge to target the recovery in household consumption as the country’s growth target of 5 per cent in 2024 appears unattainable.

Shortly after, the People’s Bank of China (PBOC) followed through as it cut interest rates by 10 basis points, its first since 2023. The central bank also issued RMB 200 billion (USD 28 billion) worth of one-year loans at a cheaper rate to boost onshore liquidity and bring overall borrowing costs down. In parallel, the state also announced fresh subsidies for families to buy locally produced EVs and new homes.

It is not so much the size of the interest rate reduction. Instead, the PBOC’s move delivers on Xi’s vow to support domestic consumption, and fast. The sooner that interest rates are reduced, it is believed that consumers will grow comfortable spending more.

The economy expanded by 4.7 per cent in the second quarter, sliding from the 5.3 per cent increase in January-March and missing market expectations. Consumer spending accounts for 37 per cent of GDP based on World Bank data, a figure that has declined from a peak of 72 per cent in 1962.

Graph 1 illustrates China’s progress in raising the share of household consumption to overall GDP since the 2010s when it pursued a structural rebalancing, or the shift to domestic rather than external demand-driven economy. However, China is far from reaching the highs of the consumption-to-GDP ratio seen in past decades. This shows that there is sufficient elbow room to expand domestic private consumption.

The recent rate cut is expected to revive consumer confidence and therefore personal spending, which in turn will lift growth.

Global hit

It is not just the domestic economy that is suffering from China’s private spending slump. Global luxury brands have attributed their missed sales targets so far this year to double-digit declines in the Asian market, largely due to China. This phenomenon, dubbed as “luxury shame” as Chinese nationals shirk flashy or high-fashion purchases amid tough times at home, had been observed during the 2007-2008 Global Financial Crisis.

In boosting consumer demand, however, we think that the government will focus not on the luxury or high-fashion segment, which is said to account for just some 2.4 per cent of GDP. Rather, any stimulus to boost consumption would mainly target the low- to middle-income citizens, which would assist purchases of food and locally made gadgets for example.

State-owned enterprises (SOEs) are expected to play bigger roles in China’s quest to return to a high growth path.

We see that these Chinese SOEs will be at the front and center of this modernization push and would be key in raising domestic demand to edge out Western manufacturers in what could shape up as a government-financed competition. This would characterize the Xi-style modernization approach. For example, China-owned EV manufacturers like Changan, GAC, and Chery will be getting a boost in sales after the central government dangled subsidies of up to RMB 10,000  (USD 1,400) for households to discard traditional fuel cars for EVs. Although the subsidy would only be for Chinese nationals, it would still create a ripple effect of lowering prices for China-made EVs for the rest of the world. A separate domestic subsidy allows for cheaper rent on apartments, which is also meant to spur demand for residential properties to save the ailing residential property sector.

China’s economic future

We continue to expect China to be the world’s single largest market, with its population of over 1.4 billion and high GDP per capita of USD 12,614 in 2023 (versus the global average of USD 13,138). As discussed above, household spending patterns in the Chinese mainland make or break global demand.

This view is also supported by China’s lasting legacy as the biggest manufacturing powerhouse globally, also fueled largely by SOEs and public sector subsidies.

As seen in Graph 2, China accounts for nearly one-third of global manufacturing output as of 2021. Valued at USD 4.9 trillion, China’s value added easily dwarfs the cumulative factory output of the EU as well and even of Latin America, based on World Bank data. This shows just how dominant the Chinese economy is in the global context. At a time of weak external demand – as global consumers are hounded by elevated interest rates mainly due to the US Federal Reserve, and as higher tariffs are imposed on Chinese goods – China’s quest to raise domestic demand is necessary if it wants to unlock faster expansion.

Despite these headwinds, it is undeniable that China’s GDP growth will continue to beat the pace of developed nations. The Communist Party’s vision for the Chinese economy is in the right direction, underlining China’s focus on domestically driven expansion. We await more specific cues for its execution that would slowly but surely revive confidence in this market.