Abstract: At a recent CF40 seminar, experts agree that China's economy will rebound in 2023, but disputes remain over the strength of the rebound, which is caused by the different views on the scarring effect left by the pandemic and the recovery momentum of the real estate sector. At present, China's economy is in the early stage of bottoming out, providing a window period for the macro policy to play a pivotal role. Experts called for more vigorous fiscal policy, breaking the 3% deficit rate constraint and focusing on subsidizing low-income households and SMEs. Further easing monetary policy should be adopted to support economic recovery and release positive policy signals to the market. Moreover, China should also seize the opportunities brought by an improved macroeconomic environment and push forward economic reforms to increase the potential growth rate.
I. CHINA'S ECONOMY IS EXPECTED TO STABILIZE AND REBOUND IN 2023, BUT UNCERTAINTY REMAINS ABOUT THE STRENGTH OF THE RECOVERY
Recently, the two main factors that used to hamper China's economic recovery have changed fundamentally with the continued optimization of pandemic prevention and control measures and the introduction of policies to support the real estate sector one after another. Experts at the seminar agreed that China's economy will rebound in some degree in 2023. However, disputes remain on how strong economic rebound eventually will be.
1. Why do some hold economic recovery would be somewhat limited?
First, the pandemic shock has medium- to long-term implications for the household and corporate sectors. Experts at the seminar suggested that the macro level may characterize economic improvement in the next stage, while that at the micro level still limited. The pandemic has caused greater damage to the balance sheets of residents and small and medium-sized service businesses, leading to a change in their long-term expectations. Even when the pandemic shock subsides, these market players will find it hard to quickly return to their pre-pandemic levels in terms of consumer and investment demand, a phenomenon defined as a scarring effect in some studies.
Second, the real estate sector still faces tremendous debt pressure, while long-term factors, including slowing urbanization and changing demographics, have determined that house demand will remain on the downward track. China recently introduced various policies in support of the real estate sector, especially financial policies. Experts believe that the policies will gradually take effect in revitalizing the industry, but as of today, real estate developers remain heavily indebted. Longer-term factors such as slowing urbanization and high house price-to-income ratio have also added to cautious optimism about the sector’s future.
2. Reasons for expecting a robust economic rebound
First, Covid policy adjustment will unleash pent-up demand and stabilize production, promoting fast economic recovery. Experts point out that experiences of other east Asian economies suggest that the first quarter after Covid policy relaxation is likely to see the economy and consumption further battered due to the fast contagion of the virus; but it will be followed by a rebound without significant scarring effect, as pent-up demand especially demand for services pick up and manufacturers get back on their feet, driving growth in investment as well. Some estimate that people postponed around 14% of China’s total retail sales in 2022 due to Covid, which will significantly drive economic recovery.
Second, the real estate sector has dipped to a below-trend position, and with the policy turn, the real estate market is expected to stabilize soon and be less of a drag on the economy. Experts note that this wave of real estate collapse has been unprecedented, with the floor area of newly constructed houses almost halved from the 2019-2022 average. Even if slowing urbanization, demographic changes and other long-term factors have already determined a decrease in house demand in China, house supply today is very likely to have fallen below the long-term trend, with some places already seeing a gap between house supply and demand. Meanwhile, policies introduced are expected to have immediate effects in channeling funds to real estate developers and improving their cash flows, thus promoting building more houses. Hence, the long-term decrease in demand will not stem the sector’s near-term recovery.
Views differ on the expected inflation level and the RMB exchange rate trend next year.
Some predict that the economic rebound and inflationary pressures will be muted next year. However, the risk of a "dollar shortage" in the international market remains. The current interest rate differential between China and the United States is already significant. The service trade deficit will continue to grow after the economy reopens. As a result, the pressure on capital outflows will continue, and the RMB will continue to face depreciation pressure.
Others argue that, based on international experience, most countries will experience a new round of inflation after the pandemic passes, but the persistence of inflation will vary to some extent. Therefore, as Chinese economic prosperity accelerates, inflationary pressures may emerge in the second half of 2023, as well as inflationary pressures caused by phased supply-demand mismatches. Meanwhile, the Fed's rate hikes in the coming year are expected to slow. Capital outflows from China will be slightly lower than this year. The RMB faces little unilateral depreciation pressure, and two-way fluctuations are more likely.
II. THE MACROECONOMIC POLICY IS IN A GOOD POSITION TO EXERT FORCE
The Chinese economy is in the process of bottoming out and rebounding. The rebound momentum is strong, making it easier for market participants to band together. At this point, expanding the role of macroeconomic policies can achieve twice the result with half the effort. As a result, macroeconomic policy is in a good window of opportunity, and both fiscal and monetary policy should make a difference in getting China's economy back on track for potential growth as soon as possible.
First, fiscal policy should step up to slightly go beyond the 3% constraint on the deficit rate and focus on subsidizing low-income households and micro and small businesses. Experts pointed out that the so-called 3% redline on fiscal deficit does not constrain most countries’ policies, and neither should it become China’s policy basis. Meanwhile, as China’s public debt has not yet become a constraint on fiscal policy, the budgetary deficit rate should be allowed to rise above 3% at certain times. Academic research and international experience have shown that, targeted fiscal subsidies can offset the mid-to-long-term impacts of disaster-induced shocks to households. Therefore, expanding budgetary deficits and spending more on transfer payments can both stabilize short-term demand and improve long-term expectations.
Second, monetary policy still has ample space. Several experts noted that monetary policy still has room for rate cuts to inject liquidity, which is critical to shoring up economic recovery. Rate cuts, coupled with economic improvement due to optimized pandemic control measures, will unleash new demand for credit. At the same time, loosened monetary policy also sends positive signals, which can enhance market expectations. If the economy outperforms market expectations, monetary policy can also adjust and respond to it in a more flexible way.
Lastly, we should seize the opportunities brought by an improved macroeconomic environment and push forward economic reforms to increase the potential growth rate:
1. We should expand fiscal spending, sort out the central-local government fiscal relations and optimize local government’s revenue sources.
2. Regulatory policies should be more stable and transparent, with fewer unnecessary administrative interventions.
3. Preferential measures should be introduced by stage, such as tax incentives for new companies to stimulate market vitality.
This article is a summary of the discussion contributed by speakers at the closed-door seminar China’s Macroeconomic Prospects and Market Outlook at the Bund Summit. It was compiled by Zhu He and translated by CF40.
