China has reported the fourth continuous month of contraction in manufacturing activity, indicating that sluggishness in the economy has continued.
Even non-manufacturing activity in the country has hit its lowest point since the beginning of the year. The non-manufacturing PMI is just above the 50 points mark, which indicates a small expansion.
Exactly a week back, Chinese leadership indicated that recovering to pre-pandemic economic conditions would be difficult.
A deflationary scenario in China is a cause of concern for investors, unlike the rest of the world economy, where inflation is the primary concern.
Prices of commodities like chemicals, textiles, steel, and cement have seen declines as input prices and demand both fall.
Further, the capacity put up during the pandemic-induced export boom has seen lower-than-expected utilisation due to lower domestic consumption. Hence, lowering prices as a means to sell inventory and increase utilisation has aggravated the deflation scenario.
Real estate prices, too, have been on a downtrend, which is in sharp contrast to the pre-pandemic years, when real estate was seen as a sure-shot means to make money.
Evergrande, one of the symbols of excesses in the Chinese real estate sector, still struggles to pay back its $ 300 billion in liabilities.
Even vehicle manufacturers have cut back on prices to grow sales, while consumers continue to hold back on spending.
China's lengthy lockdown, combined with crackdowns on various sectors, has spooked investors.
The Hang Seng Index, which jumped 50 per cent from the lows it hit in November of 2022, has now moderated to levels it was at exactly a year ago.
While investors cheered the economy's reopening, the unexpected slowdown caused them to re-think their guesses.
Over the past year, inflows into emerging markets, excluding China, have outpaced inflows into China, indicating that money is chasing economies that have a much clearer growth outlook and regulatory stability. India, too, is expected to be a beneficiary of money flowing into other emerging markets.
However, even for India, China's troubles might be nothing to cheer about.
A deflationary environment and weak domestic demand in China would make its exports competitive compared to other large exporters like India, as Chinese players would look for lucrative markets outside their home territory.
Further, domestic demand declines would hurt the economies of countries that export products like oil, minerals, machinery, electrical components and other materials to China – which could lead to a slowdown in the global economy.
Given the current market conditions, it appears that investors are still betting that China will recover.
The risks from a longer deflationary period in China probably are not being considered by investors currently.
Persistent deflation is a problem that has haunted the economies of countries like Japan.
Since consumers keep putting off purchases in hopes of lower prices in the future, demand weakens further. As a result, the companies are also less likely to invest in such economies, and a lack of investments aggravates the low-demand scenario. Ultimately, the economy falls into a state of persistent deflation.
Setting expectations play a huge role in preventing persistent deflation or inflation, and policymakers' comments and actions often play a role in setting these expectations. So far, the Chinese leadership has not given a concrete commitment to a large-scale stimulus, despite the slowdown in the economy.
The government has been working for years to reduce the economy's dependence on unbridled lending and stimulus packages, and taking a similar action now could result in the country falling into its old patterns once again.
In addition, tall claims by policymakers, which cannot be backed by action, often result in investors and the public distrusting their words in the future, making it difficult for them to influence the country's trajectory. This could be another reason behind China's policymakers' reluctance to give detailed explanations about its future course of action, despite the state of the economy.
However, small changes are being made to boost economic growth.
For instance, tax incentives have been offered to buyers of electric vehicles, and the government has made promises of lower charging costs. The People's Bank of China has cut interest rates, while the government's long crackdown on the financial sector appears to have ended.
Similarly, local governments have promised easier credit for customers to fund the purchase of consumer-durable items.
The embattled property market, a large contributor to China's economy and job market, is also expected to see policy support.
The Chinese government, which has strongly opposed people flipping houses (buying and selling in expectation of a profit), seems to have changed its stance.
According to the South China Morning Post, the phrase "housing is for living, not for speculation" appears to have been removed from the official announcement for the first time in the last five years.
The Chinese government has been asking provincial governments, which have strong control over the real estate sector, to ease policies and help the sector recover. However, despite these measures, Beijing has continued its crackdowns against foreign companies operating in sectors like semiconductors, consulting, and auditing.
A slowdown in one of the largest consumers will impact the global economy in a globalised world.
Back in 2016, a slowdown in the Chinese economy caused a meltdown in the financial markets of both developing and emerging economies.
Some analysts believe that the stock market rallies in developed and emerging nations might not be pricing in the trouble in China.
In the unlikely scenario that China does fall into a crisis, the global markets might see a period of turmoil.
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