Projected to contribute to a third of this year’s global economic growth, China’s substantial economic deceleration in recent months has sparked concerns on a global scale.
As China’s imports, ranging from construction materials to electronics, experience a decline, policymakers are preparing for the potential impact on their economies. Caterpillar Inc. reports that the demand from China for construction machinery has turned out to be more challenging than initially anticipated.
Referring to the economic challenges as a “ticking time bomb,” US President Joe Biden emphasized their urgency. Global investors have already withdrawn over $10 billion from China’s stock markets, with a majority of the sales affecting blue-chip stocks. Goldman Sachs Group and Morgan Stanley have lowered their projections for Chinese equities and the former has additionally cautioned about the potential spill-over effects on the broader region.
Asian economies are currently bearing the brunt of the trade impact, closely followed by nations in Africa. Japan, for instance, experienced its first decline in exports in over two years in July, attributed to China’s reduced acquisition of automobiles and semiconductor chips. Recently, central bankers from South Korea and Thailand downgraded their growth predictions, citing China’s sluggish recovery as a factor. However, amid these challenges, there are still positive aspects to consider.
The deceleration of China’s economy is expected to have a downward effect on worldwide oil prices, while the prevalence of deflation within the country contributes to the decreasing prices of goods being transported globally. This trend presents an advantage for nations such as the US and UK, which are grappling with elevated inflation rates. Additionally, certain emerging markets like India are eyeing potential opportunities as they aim to draw in foreign investments that might be redirected away from China.
However, considering China’s position as the world’s second-largest economy, an extended period of economic slowdown within the country would have adverse effects on the global stage, rather than offering benefits. The International Monetary Fund’s assessment underscores the significance of this situation: a mere 1-percentage-point increase in China’s growth rate corresponds to a 0.3-percentage-point enhancement in global economic expansion.
China’s deflationary situation may not be entirely detrimental for the global economy, as Peter Berezin, the Chief Global Strategist at BCA Research. However, if scenarios unfold where the US and Europe slip into recession while China’s weakness persists, it could pose a substantial issue. This predicament wouldn’t solely impact China but rather reverberate across the entirety of the global economy.
Let’s examine how China’s economic deceleration is causing effects across various economies and financial markets.
Numerous nations, particularly those in Asia, heavily rely on China as their primary export destination, encompassing a wide range of goods from electronics and food to metals and energy resources. Over the past ten months, the value of Chinese imports has declined in nine out of ten instances, as demand recedes from the peak levels reached during the pandemic. This trend is reflected in the decreased value of shipments from Africa, Asia, and North America in July, compared to the corresponding period the previous year.
Africa and Asia have borne the brunt of the impact, experiencing a decline of over 14 percent in the value of imports during the initial seven months of this year. This can be attributed in part to reduced demand for electronic components from South Korea and Taiwan. Moreover, the diminishing prices of commodities, including fossil fuels, are also contributing to the decreased value of goods being exported to China.
Currently, the physical quantity of commodities like iron or copper ore dispatched to China has remained relatively stable. Nevertheless, if the ongoing economic slowdown persists, there’s a possibility of disruptions in these shipments. Such an outcome could have repercussions for miners in regions like Australia, South America, and other parts of the globe.
Over the last ten months, producer prices in China have consistently declined, leading to a decrease in the expense of goods being exported from the nation. This development brings relief to individuals worldwide who are grappling with elevated inflation rates. The cost of Chinese products arriving at US ports has exhibited a monthly reduction throughout this year, a trend expected to persist until factory prices in China show a return to positive territory.
Economists at Wells Fargo & Co. have projected that if China were to experience a ‘hard landing,’ defined as a significant 12.5 percent deviation from its anticipated growth trend, it could lead to a reduction of the baseline forecast for US consumer inflation in 2025 by 0.7 percentage points, resulting in a figure of 1.4 percent.
Chinese consumers in recovery mode are directing their expenditures towards services, particularly in areas such as travel and tourism, surpassing their spending on goods. However, the trend of venturing abroad in significant numbers is yet to fully materialize.
Until a short while ago, the government had prohibited group tours to numerous nations, and even now, a scarcity of flights remains. As a result, traveling has become considerably pricier compared to the pre-pandemic period.
The pandemic and the economic downturn have constrained incomes in China, and the extended period of decline in the housing market has led homeowners to perceive reduced wealth compared to previous times. This implies that the revival of overseas travel to pre-pandemic levels might be a prolonged process, adversely affecting nations in Southeast Asia that heavily rely on tourism, such as Thailand.
The challenges faced by China’s economy have caused its currency to weaken by over 5 percent against the dollar in the current year, bringing the yuan perilously close to the 7.3 mark this month. In response, the central bank has intensified its efforts to safeguard the yuan, employing various measures including its routine currency fixings.
Bloomberg data illustrates that the decline of the offshore yuan is exerting a more pronounced influence on its counterparts in regions such as Asia, Latin America, and the Central and Eastern Europe bloc. The correlation between the Chinese currency and certain other currencies has been observed to be increasing.
As correlations strengthen, the subdued sentiment spillage could potentially impact currencies like the Singapore dollar, Thai baht, and Mexican peso, as stated by Barclays Bank Plc. Magdalena Polan, head of emerging market macro research at PGIM, expressed concern about metal-exposed currencies and remarked:
“Given China’s weaker economy, it’s challenging to hold an optimistic view on Asian economies and currencies.”
According to her, the currency of commodity-driven economies like the Chilean peso and South African rand could face setbacks due to vulnerabilities in the construction sector. The Australian dollar, often seen as a gauge of China’s performance, has experienced a decline of over 3 percent in this quarter, emerging as the weakest performer within the Group-of-10 basket.
Bonds lose appeal
The interest rate reductions implemented by China this year have diminished the attractiveness of its bonds for foreign investors. As a result, these investors have scaled back their involvement in the market and are exploring alternative options within the broader region.
Bloomberg calculations indicate that foreign holdings of Chinese sovereign bonds currently represent the smallest proportion of the total market since 2019. As central banks in South Korea and Indonesia approach the end of their interest-rate hiking cycles, global funds have become more optimistic about the local currency bonds of these countries.
A range of companies, including Nike and Caterpillar, have revealed a decrease in their earnings due to China’s economic slowdown. An MSCI index that monitors global firms with substantial exposure to the Chinese market has fallen by 9.3 percent this month, nearly twice the drop seen in the broader measure of worldwide stocks.
Indicators for European luxury goods and the travel and leisure industry in Thailand also mirror the declines in China’s domestic equity benchmark.
“These sectors offer precise indications of how international investors might indirectly engage with China and its economic prospects,” explained Redmond Wong, a market strategist at Saxo Capital Markets in Hong Kong.
Luxury goods companies like LVMH, the producer of Louis Vuitton bags, Kering SA, the owner of Gucci, and Hermes International are especially susceptible to fluctuations in Chinese demand.