Explainer: What is pushing China towards economic slowdown & how it may impact India

NEW DELHI: China, the world’s second largest economy, is slowly but surely moving towards an economic slowdown.
Persisting geopolitical challenges amid the ongoing Russia-Ukraine war, high global inflation and frequent lockdowns due to its strict Covid Zero policy have all combined to put the Chinese economy under pressure.
The recent power shortage and the unprecedented hot weather across the country are set to further complicate the task of Chinese policymakers.

Covid Zero policy battered economy
China’s zero tolerance for Covid and the disruptive measures being taken to contain any flare-up have proved to be a bane for the economy. The impact is both direct and indirect, hampering both supply and sentiments.
As of August 15, 22 cities accounting for 8.8% of China’s gross domestic product, were under full or partial lockdowns, according to Nomura.
The containment measures have surely crushed the morale of the people. Consumer sentiments have weakened, the property sector is witnessing its own challenges, thereby reducing the scope of investments further.
Where does economy stand
China’s economic growth slowed sharply in the second quarter, expanding 0.4% year-on-year and missing expectations, as widespread lockdowns to curb record Covid cases during the quarter hit industrial activity and consumer spending.

Industrial output grew 3.8% in July from a year earlier, according to the National Bureau of Statistics (NBS), below the 3.9% expansion in June and a 4.6% increase expected by analysts in a Reuters poll.

Retail sales in July, which had just returned to growth in June, rose 2.7% from a year ago, missing forecasts for 5.0% growth and the 3.1% growth seen in June.

“The July data suggests that the post-lockdown recovery lost steam as the one-off boost from reopening fizzled out and mortgage boycotts triggered a renewed deterioration in the property sector,” said Julian Evans-Pritchard, senior China economist at Capital Economics.
China’s economy narrowly escaped a contraction in the June quarter, hobbled by the lockdown of the commercial hub of Shanghai, a deepening downturn in the property market and persistently soft consumer spending.

Risks still abound as many Chinese cities, including manufacturing hubs and popular tourist spots, imposed lockdown measures in July after fresh outbreaks of the more transmissible Omicron variant of the coronavirus.
Fixed asset investment, which Beijing hopes will compensate for slower exports in the second half, grew 5.7% in the first seven months of 2022 from the same period a year earlier, versus a forecast 6.2% rise and down from a 6.1% jump in January-June.
The employment situation remained fragile. The nationwide survey-based jobless rate eased slightly to 5.4% in July from 5.5% in June, although youth unemployment stayed stubbornly high, reaching a record 19.9% in July.

Wobbly property market
The debt crisis in China’s property sector has worsened in recent weeks after a growing number of homebuyers threatened to stop making mortgage payments on stalled property projects, aggravating a crisis that could lead to social instability.
The property sector’s credit troubles risk seeping into secondary industries such as asset management companies, privately-owned construction firms and small steelmakers, said Fitch Ratings in an August note.
In fact, China’s real estate sector has been lurching from one crisis to another over the past year, as it grapples with mounting liabilities, a slowing economy and flagging demand, while its sources of fresh fundraising have been drying up.

Some big private developers like Evergrande have already defaulted on offshore debt obligations and struggled to raise funds from other sources, including banks.

A recent report by UBS estimated the property crisis in China to get worse, wiping off $1 trillion from the global market.

In other words, what started as trouble with China Evergrande Group is now snowballing into a crisis that risks engulfing the majority of the country’s developers, its biggest lenders and a middle class that has significant wealth tied to the property market.
As a result, home sales tumbled 41.7% in May from a year earlier, with investment drop of 7.8%.
Fall in bank loans
China Banking and Insurance Regulatory Commission (CBIRC) is looking at banks’ loan book exposure to property developers to find out if those credit decisions were made according to the rules, Reuters reported quoting sources.

The aim is to measure risks to the financial system from the ongoing property sector turmoil in the world’s second-largest economy, two of the sources said. It was not immediately clear what action the regulator might take after the investigation.
The latest probe comes as policymakers have been trying to stabilise the property sector, which accounts for a quarter of the economy, after a string of defaults among developers on their bond repayments and a slump in home sales.
Property loans accounted for 25.7% of total banking sector credit in China as of end-June, central bank data showed. The banking sector’s total outstanding loans was 206 trillion yuan ($30.3 trillion) at the end of the first half.

Commercial banks’ non-performing loan ratio stood at 1.67% at the end of June, down from 1.73% at the beginning of this year, according to CBIRC data, though many analysts believe the real number is much higher.
New bank lending in China tumbled more than expected in July while broad credit growth slowed, as fresh Covid-19 flare-ups, worries about jobs and the property crisis made companies and consumers wary of taking on more debt.
Yuan near 2-year low
China’s yuan slumped to a near two-year low against the dollar on Monday, as Beijing stepped up easing measures.
Currency traders and analysts said a firmer dollar and weaker domestic economic fundamentals both contributed to the yuan’s declines.
The selling pressure on the yuan has grown since the PBOC surprised markets by cutting two key interest rates earlier this week, traders say.
Widening policy divergence, along with worries over weaker economic fundamentals, raised the risks of capital outflows and yuan depreciation.
Yuan’s fall dragged down most emerging market currencies.

What is central bank doing
At a time when central banks of most major economies are raising benchmark lending rates as a measure to curb soaring prices of commodities in their respective countries, the central bank in China has slashed the rates.
The People’s Bank of China (PBOC) cut its benchmark lending rate and lowered the mortgage reference by a bigger margin on Monday, adding to last week’s easing measures.
The one-year loan prime rate (LPR) was lowered by 5 basis points (bps) to 3.65% at the central bank’s monthly fixing on Monday, while the five-year LPR was slashed by 15 bps to 4.30%.
To prop up growth, the central bank on Monday unexpectedly lowered interest rates on key lending facilities for the second time this year. Analysts expect the cut is likely to lead to a corresponding reduction in benchmark lending rates next week.

Many believe the room for the People’s Bank of China to ease policy further could be limited by worries about capital outflows, as the U.S. Federal Reserve, and other economies, aggressively raise interest rates to fight soaring inflation.
“Very sluggish credit demand in July on the back of weak activity growth, further deterioration in property indicators and lower-than-expected CPI inflation might have contributed to the PBOC’s move,” said analysts at Goldman Sachs.
Chinese policymakers are trying to balance the need to shore up a fragile recovery and eradicate new Covid-19 clusters. As a result, the economy is expected to miss its official growth target this year – set at around 5.5% – for the first time since 2015.
How it may impact India
When the 2nd largest economy of the world faces an economic downturn, it is sure to have an impact on other economies as well. The possibility of slowdown is a cause of concern, especially at a time when world’s largest economy — the United States — is staring at a possible recession.
If the top 2 major economies of the world face economic challenges, it is sure to add fuel to the debate of a possible global slowdown that will spare no economy — big or small.
Even though it won’t be spared from the spillover effects of a global recession, India may benefit from a Chinese slowdown. The first global impact of a Chinese slowdown will be a fall in global oil prices. We all know that India is a net importer of oil. Any fall in global oil prices will help India cut down its imports bill.

It will also ease the pressure on rupee and will give a boost to India’s foreign reserves.
Further, the Russia-Ukraine war and China’s belligerent posturing towards Taiwan have raised the stakes high for the US and other western nations. The West is more sincerely looking at reducing their dependence on China and expanding their sourcing base. Now, India has an opportunity to gain market share. If it can strengthen the manufacturing sector further, India will be able to attract more global investments and can hope to emerge as an alternative global manufacturing hub vis a vis China.
However, there is a downside to a Chinese slowdown for India. In terms of bilateral trade, China has been one of India’s top trading partners since long. It is on course to cross $100 billion for the 2nd consecutive year.
In the first half of this year, India’s trade with China has gone up to $67.08 billion.
China’s exports to India have gone up to $57.51 billion, up by 34.5% since last year. While, Indian exports to China fell to $9.57 billion, a decline of 35.3% compared to last year, according to the trade data released by China’s General Administration of Customs (GAC).
Interestingly, of the total imports from China in FY21, majority of the commodities and goods were where India introduced the production-linked incentive (PLI) scheme like textile, agri, electronics goods, pharmaceuticals & chemicals.
In FY22 April-December period, there were 6,367 products with a total value of $68 billion (or 15.3 per cent of the total imports) imported by India from China.
Therefore, a slowdown in India’s top trading partner will hit bilateral trade as well. With overall demand slowing down, it may impact both inbound and outbound supply of goods and services between the two nations.
(With inputs from agencies)