China, China, China
In the latest World Economic Outlook published by the IMF on 11th April, a gloomy tone on the global economy was conveyed. Indeed, it appears that the global fortunes continue to deteriorate. One of the main composites of this depressing outlook is the expected level of inflation worldwide.
As we have stressed multiple times in earlier issues, inflation is indeed a sticky phenomenon. Even though targets vary for each Central Bank, most developed economies aim at the magic number of 2%. In the absence of a major slowdown, core inflation – which excludes food and energy due to their volatility – is extremely difficult to tame via the usual monetary measures.
The raising of interest rates started in March 2022, when the U.S. Federal Reserve (FED) could no longer dismiss inflation as transitory and became extremely hawkish. This forced other countries to follow the U.S. footsteps. However, financial players that have been so addicted to low interest rates, hoping for a quick policy pivot, did not reposition their portfolios accordingly. The bank failures that occurred in U.S. and Europe during Feb 2023 were the inevitable consequences. While this has been preemptively contained by central banks, this resulted in even stringent lending conditions for companies and individuals.
While no crash is expected so far, the global economy is fragile. Monetary authorities are caught in a difficult position. Either they raise interest rates and risk banking stability, or they don’t, and inflation could catch a breather before coming back stronger. Regardless of both situations, this does not bode well for the global economy.
It is a well-known fact that shipping thrives on a healthy economic climate pushing us to wonder how long could trade volumes sustain if economic prospects continue to limp.
In the April IMF report, global inflation forecast has been revised to nearly 7% as compared to Jan-23’s 6.6% (see Chart I). As such, it is just a matter of time before trade volumes get materially affected, which would induce downward pressure to freight rates. However, the lag time effect between monetary policies and absolute decline in real output will muddle most forecasts’ horizons.
On paper, growth prospects in trade volumes look better than expected (see Chart II), but this is relative to the 6% decline in 2020. While growth rates have improved from 2021 till date, we are just making up to lost ground as far from beating pre-pandemic levels.
If global trade volumes were to defy the earlier mentioned headwinds in order to satisfy IMF’s forward growth projection, what are the critical points needed?
China, Obviously. Unlike other countries, China doesn’t seem to be inflicted with high inflation. On the contrary, according to the National Bureau of Statistics (NBS), in March 2023, China’s consumer price index (CPI) rose only by 0.7% year on year. This reflects weak domestic demand, and the possibility of China heading to deflation. China’s official data released in April showed an encouraging outlook with Q1-2023 GDP growing by 4.5% year-onyear, above consensus expectations of 4%.
However, taking a deeper dive into these headline numbers suggests there’s more to this than meets the eye.
GDP = Consumption + Investments + Government Spending + Net Exports
Consumption: China’s domestic economy in Q1-2023 exhibits some strength. But is this a dead-cat bounce following the removal of the zero-covid policy or the beginning of a sustainable rally? Looking at the People’s Bank of China (PBOC) data, it seems more of the former than latter. While domestic spending has increased, bank savings had reached new highs in 2022 (See Chart III).
In a recent PBOC survey held in Q1-2023, 23.2% of the surveyed preferred more consumption, opposed to an overwhelming 58% preferring more savings deposits. the consumption pattern leans heavily towards services (education, healthcare, tourism etc.) rather than housing purchase.For example, willingness to save in the first quarters of 2019 to 2022 was 45%, 53%, 49.1% and 54.7% respectively. While we bid zero-covid goodbye, the saving rates did not retrace back to 2019 prepandemic levels. Instead, it continued to march on. Supporting this observation is the China Consumer Confidence Index which remain in the doldrums (See Chart IV), even after Feb 2023 improvement.
On a side note, youth unemployment is uncomfortably high, at 19.6% in March 2023, the forward appetite for fresh consumption lacked substance.
Investments, comprising of domestic and foreign investments. Domestic investment is mainly driven by the real estate market under the private sector.
In the first two months of 2023, the real estate investment (residential buildings, factory buildings, hotels, etc.) in China declined by 5.7% year-on-year (See Chart V). In addition, there has been a 9.3% and 3.6% year-on-year drop in new home construction and building sales, respectively.
Policy measures set by the government to support the property sector such as the removal of the three red lines, and lowering down payment ratios and mortgage rates for first-home buyers has thus far been inadequate to drag the property market out of its funk.
FDI into China had declined from Q2-2020 to Q4-2022 in tandem with the duration of covid restrictions. While numbers have improved in Q1-2023 (See Chart VI), it is uncertain whether or not foreign companies will keep investing in China in the future.
The shift had already emerged in recent years, according to an IMF analysis that showed foreign direct investment from the second quarter of 2020 to the fourth quarter of last year declined by almost 20% from pre-pandemic levels.
Exports: This has been a mixed picture, with Jan-Feb dropping by 6.8% according to China’s customs but exports rose by 14.8% in dollar terms in March. However, March’s performance could reflect a catchup caused by monthly volatility, post Chinese new year holidays.
Last month’s improvement are mainly led by exports to ASEAN countries. However, it is unlikely that ASEAN’s appetite can completely replace China’s main trading partners - the US and the EU down the stretch. The real challenge will likely surface in 2H2023 when the US economy might languish and the effects of monetary policy tightening by the FED on China’s exports will materialize.
Lastly, with consumption weak, domestic and foreign investment lackluster, and exports on a limp, the only reliable option left would be government-led infrastructure spending.
To fund such expenditure, either tax is raised, or debt is issued. It has been well reported that China has been suffering from a budget deficit with local provinces needing help from the central government to tide through tough times. In the future, the possibility of a top-down bailout by Beijing seems remote, as local governments are left to their own devices to solve their debt problems. It appears that issuance of debt is a no-brainer as multiple reports of China selling Infrastructure bonds in 2022 surfaced.
Hence, infrastructure spending is riding on steroids rather than a genuine recovery which casts doubts on its long-term sustainability and effectiveness. Meantime, according to AXSMarine data, iron ore seaborne volumes into China for Q1-2023 grew by 10.5% year-onyear. Whether such blistering growth could be duplicated in Q2 and Q3 remains to be seen.
All in all, while China is certain to recover in 2023 relative to a dismal 2022, we believe it is too soon to assume that the path is a smooth sailing one. Hence, we retain our initial assessment that China’s recovery would be an L-shaped one, with upside if any, to occur at earliest by Q3-2023. However, we would not be surprised if there would be delays given the uncertainties that are encircling China and the global economy. Moving ahead, shipping would be exposed to the vagaries of such developments.