[Trapped in the Chinese Economy] ① Deflation Fear Hits China... Domestic Demand Slump Is a 'Fatal Blow'

[Image source=AP Yonhap News]

China, the world's second-largest economy, is facing a 'deflation' crisis. This is in stark contrast to major countries worldwide such as South Korea, the United States, and Europe, which are still struggling with inflation. It signifies just how weak the Chinese economy is. Since the lifting of COVID-19 restrictions, the Chinese economy, which had dreamed of a spectacular rebound, has been sluggish mainly due to a domestic market slump. Household consumption and corporate investment have frozen amid falling asset prices such as real estate, and the government, which used to stimulate the economy by injecting funds during crises, cannot introduce groundbreaking fiscal policies due to massive debt.

China's High Dependence on Domestic Demand... Declines in Consumption and Investment Are a Fatal Blow

China's Consumer Price Index (CPI) has recorded a year-on-year increase rate in the 0% range for four consecutive months since last March. The Producer Price Index (PPI) has been declining for nine consecutive months. Retail sales in June rose by 3.1%, lower than market expectations (3.2?3.5%), and private investment shrank further for two consecutive months in May (-0.1%) and June (-0.2%). Even in the first half of the year, the growth rate of retail sales for home appliances was 1.0%, and for communication devices, 4.1%, both falling short of expectations. Because the economy is weak, household and corporate consumption and investment decrease, creating a vicious cycle that leads to further economic stagnation.

The slump in private consumption is critical from China's perspective. Since the 2008 financial crisis, China has pursued an economic development strategy focused on the domestic market rather than exports. While South Korea's economy heavily depends on exports to the extent that it is said to 'live off exports,' China, conversely, has a domestic market accounting for more than half of its Gross Domestic Product (GDP). The contribution of final consumption to growth in the first half of this year reached 77.2%. The domestic demand supported by a population of 1.4 billion is currently the biggest growth engine of the Chinese economy.

Recently, the Chinese government has been focusing on expanding domestic demand, including consumption and investment, to revive the economy. At a briefing at the end of last month, the National Development and Reform Commission of China stated, "The consumption sector led China's economic growth in the first half of the year, and in the second half, we will continue to implement policies to activate consumption to solidify the trend of economic growth driven by domestic demand." In a situation where the United States and its allies are intensifying their containment of China, it is crucial for China, which finds it difficult to rely on exports and other external factors, to restore domestic demand.

Despite Stimulus Measures, Chinese Prefer Saving Over Consumption... Will Deflation Occur?

However, many analyses suggest that private consumption and investment will not recover quickly despite the Chinese government's efforts. The Bank of Korea recently explained regarding the outlook for the Chinese economy, "The sluggishness in real estate development investment is likely to continue in the second half of the year," adding, "The delay in the real estate market recovery is also affecting the weakening of consumption sentiment among middle- and high-income groups through wealth effects." Real estate and construction hold a significant share in China's domestic market, and if the real estate downturn continues, it will be difficult for consumption and investment sentiment to recover.

Lee Chi-hoon, head of the Emerging Economies Department at the International Finance Center, said, "The downward pressure on the Chinese economy is greater than expected, consumption is weak, and there are concerns about a double-dip (temporary recovery followed by renewed recession) in real estate," adding, "In the past, the Chinese government would have boosted the economy with stimulus measures in such situations, but now it lacks the fiscal capacity to do so." Although the Central Political Bureau, China's top decision-making body, hinted at easing real estate regulations to activate domestic demand at the end of last month, the market still largely views this as 'falling short of expectations.'

In particular, for private consumption expenditure to increase, disposable income must rise, but recently, China's youth unemployment rate has soared to a record high of 21.3%, indicating a poor employment market. As economic pessimism grows, Chinese households are increasing savings instead of consumption. According to the People's Bank of China, as of the end of June, yuan deposits in China amounted to 278.62 trillion yuan (approximately 4,998.6 trillion KRW), an 11% increase from a year earlier. Household deposits increased by 11.91 trillion yuan in just the first half of the year. In a situation where inflation has already sharply declined, if private consumption and investment remain sluggish, China could fall into a structural recession.

'Peak China' Becoming Reality? ... Negative Factors for South Korea's Economy Too

Consequently, market attention is focused on whether 'Peak China' is becoming a reality. The prediction that 'China's economy will peak and then decline' is an old topic that has been raised several times in the past, but this time it carries more weight. This is because factors that hinder China's recovery in the mid- to long-term, such as U.S. semiconductor export restrictions, high youth unemployment, and debt reaching its limits, are piling up. In the short term, consumption may partially revive due to the Chinese government's stimulus measures, and the economy might show an 'N-shaped recovery' in the second half of the year, but whether it will navigate smoothly in the mid- to long-term remains uncertain.

The 'Xi Jinping risk' also increases uncertainty. Since August 2021, President Xi has promoted the concept of 'common prosperity' and strengthened socialist characteristics. Although this was a desperate measure to resolve economic polarization and social imbalance, under this policy, real estate was stigmatized as a commodity encouraging speculation, and big tech companies faced extensive regulations. When the economy faltered, the Chinese government showed a zigzag approach by hinting on the 24th of last month at supporting the real estate market and reviving big tech companies. During the COVID-19 phase, President Xi strongly pushed the 'Zero COVID' policy but abruptly abandoned it earlier this year. Experts view these policy risks as factors that lower market confidence and suppress consumption.

China's sluggish consumption and investment are also negative factors for South Korea. According to a report released by the Korea International Trade Association in April, as of 2021, 76.1% of South Korea's exports to China were for the domestic Chinese market. The share of machinery for domestic use has steadily increased since the financial crisis, reaching nearly 90.6%, and although the share of electrical equipment, South Korea's top export item to China, has declined, it remains high at 69.8%. If Chinese private consumption shrinks, South Korea's export slump to China will inevitably worsen.

Massive Chinese Domestic Market... Could Rebound Overcome Crisis

Of course, many opinions suggest it is too early to talk about deflation or a long-term economic downturn in China. Although the Chinese economy has shown a sluggish recovery recently, China still has the world's largest market and controls the supply chains of key materials used in advanced equipment such as graphite and lithium. Even amid U.S.-China tensions, France has voiced opposition to containing China, and the U.S. Semiconductor Industry Association has urged restraint on additional export restrictions, indicating the strength of China's massive domestic market.

Jeon Byung-seo, director of the China Economic and Financial Research Institute, explained, "Currently, consumption activation is the growth engine of China's economy, and (government-led) investment is not the main force but a temporary stimulus measure," adding, "China is highly likely to take all possible measures to restore private consumption." Kang Sung-jin, president of the Korean International Economic Association and professor of economics at Korea University, said, "Although China has potential bad debts, the problem of high household and corporate debt is not unique to China," and emphasized, "Ultimately, if growth is achieved, the debt problem can also be resolved."