The puzzle of the Chinese economy

One week ago, China posted impressive trade statistics. In March, export growth increased by 14.8 % year-over-year versus expected minus 7 %. The monthly trade surplus was a massive $88.2bn. This was the fifth highest monthly trade surplus ever recorded by the country, all the more surprising given that March surpluses are usually small due to seasonal effects. This record is even more surprising when we compare China’s performance with that of neighboring countries. South Korean exports declined in double digits in the first quarter and it wasn’t the only export-oriented Asian economy facing a challenging start of the year – Singapore too, for instance! Looking into detail, China’s export growth was mostly driven by a strong demand in electric vehicles (+122 %), lithium-ion batteries (+94%) and solar batteries (+23%). Based on these data and the strong 4.5 % GDP growth in the first quarter, we could easily draw the conclusion that the Chinese economy is recovering fast, which will be beneficial for the global economy. Experience shows it takes about six to nine months for China’s recovery to spread across the world.

That’s not so simple, unfortunately. The surge in exports is not the consequence of a better global macroeconomic environment but rather of aggressive local government support. Since the beginning of the year, we know China is worried about weak exports. The central government has asked local governments to help businesses stabilize their exports. This is what is currently happening. The unusual March performance basically reflects subsidies and implicit transfers. In the short-term, local governments can continue supporting exporter’s competitiveness. But they will reach their limits sooner than later as they are anyway financially squeezed. Ultimately, growth in exports needs to come from the household sector. This is currently the weakest point of the Chinese economy. Since the reopening, most analysts are expecting a surge in domestic demand this year to drive overall GDP growth in a healthy way. But so far this has been very hard to find evidence of that surge in consumption. The March inflation number (at 0.7 % year-over-year) and the low level of capacity utilization in the manufacturing sector (74.3 % in the first quarter as shown by the below chart) don’t help. This is an issue for China, but also for the global economy. The mainstream market narrative is that the coming months may be bumpy, the United States may experience a 1990-style recession but the outlook will improve from year-end thanks to China’s recovery. In recent days, many analysts showed trust in this narrative by pointing out the strong GDP growth performance in the first quarter. Let’s not focus too much on the base effect related to the reopening of the economy which distorts data. They are missing a much bigger point. This is not rising GDP which drives growth across the rest of the world. Rising imports do. Unfortunately, the picture is less positive than exports with a negative print in March at minus 1.4 % year-over-year. We still expect Chinese consumption to pick up this year, therefore pushing imports upward. But it will take certainly longer and it will be probably much more complex than the market expects. This has clearly not been priced in by the market yet.