China's transition to a consumer-led economy is on hold.
Faced with plummeting output during a pandemic-hit first quarter, Beijing resorted to what it knows best and launched a 3.6 trillion yuan ($500 billion) fiscal stimulus in May aimed at boosting investment. While most developed economies directed much of their support toward workers in the form of furlough payments or, in the case of the U.S., sending checks directly to households, Chinese consumers were only secondary beneficiaries of their government's recovery efforts.
From a macroeconomic perspective, China's approach has been highly effective. After contracting 6.8% in the first quarter of 2020 — the first quarterly decline in GDP since 1992 — China's economy has rebounded strongly, beating expectations in the second quarter with growth of 3.2%. Economists at HSBC expect growth to accelerate to 5.4% year over year in the third quarter and 6.2% in the fourth quarter, with full-year growth arriving at 2.4%, contingent on further policy easing.
However, its measures to counter the coronavirus pandemic have meant the ruling Communist Party has had to put one of its long-term economic goals on the back burner: unleashing the collective purchasing power of China's 1.39 billion strong population. While private consumption is the largest element of China's economy, at 39% of GDP in 2019, it was little more than half in those of the U.S. and U.K., at 65% and 68%, respectively.
"The stimulus package was, again, very investment and business-oriented, with relatively little support for households," Louis Kuijs, head of Asia economics at Oxford Economics, said by email. "In that sense, the coronavirus outbreak, combined with the particular way that the government has responded to it, has slowed the move to a more consumer-oriented economy."
Contracting retail sales
China's economy is likely to be even more skewed to industry come the end of 2020, according to high-frequency data. Industrial production rose 5.6% year over year in August, while investment in real estate rose 4.6%, with the two metrics returning to growth in April and June, respectively.
Having collapsed by 24.5% in January-February, investment in fixed assets has recovered so quickly that the January-August total is just 0.3% below the first eight months of 2019. That number has been boosted by an 11.7% year-over-year increase in new infrastructure investment plans to drive China toward technological self-reliance, as well as a 6.4% year-over-year increase in rail transportation investment.
By contrast, indicators of household consumption have been sluggish. After seven months of year-over-year contraction, retail sales rose in August but only barely at 0.5%. The level remains a long way short of the 8% growth achieved in 2019.
Inflation has also fallen back, down to 2.4% in August from 2.7% in July, with non-food prices down 0.5% year over year, which Oxford Economics partly attributes to "the slow recovery in consumer demand."
Social safety net
Urban households enjoyed strong growth in disposable income in the years pre-virus, with gains of about 8% over the past three years, but income grew at just 1.5% in the first half of 2020.
"Importantly, the decline in wage and business income was not offset by higher welfare payments, including unemployment benefits or other transfers," said Shaun Roache, chief Asia-Pacific economist at S&P Global Ratings. "In response to these shocks, households have decided to save more to guard against future risks."
Without more in the way of government support for households, "precautionary saving" will likely linger for some time, Roache said via email.
"This underscores the importance of efforts to strengthen social safety nets, including healthcare and pension provision but also unemployment insurance, to encourage consumers to reduce their very high level of saving," he said. "We are seeing some progress here but it remains slow."
Such a system may also provide a mechanism for getting money directly to its citizens in the future instead of relying on industrial stimulus.
"China's government still does not have an effective way to get transfers to households, especially migrant worker families," said Roache. "Migrants' jobs are usually in cities but they do not qualify for benefits there. Their home local governments, meanwhile, do not have the resources or the mechanisms set up to support returning migrants. Hence the quick and time-tested way to boost the economy is infra investment."
For now, China is expected to continue to see growth in investment, with local government bond issuance accelerating and HSBC forecasting infrastructure investment to hit double-digit growth in the coming months.
Meanwhile, a strengthening global economy should see increased demand for Chinese exports, which were already up 9.5% year over year in dollar terms in August, unless a second wave of the virus derails the recovery.
"Overall, things are looking pretty solid for China's recovery but, on the normalization front, we are still seeing a dual-track economy. Capex and industrial production have normalized. Consumer spending is still nowhere near full strength," research group Trivium China wrote in a note.