Industry expanding well, but domestic consumption shows weakness

In the first three months of the year, Chinese economic growth was better than expected, at 5.3% yoy, and the latest figures also suggest solid, albeit not excessively strong growth for the current quarter. So far, so good. Upon second glance, however, it is clear that economic activity has mainly been driven by industrial production, whereas growth in services, domestic consumption, and investment has been subaverage. Naturally, these three areas depend to a large degree on the real estate sector, which of course has been Beijing’s problem child for several years now.

Once a key growth driver, for some time now real estate has been a major negative factor for growth and a potential source of instability for the financial system. Hence, it comes as no surprise that China’s leadership is trying to revive the sector more strongly now, after the focus in recent years had mainly been on mitigating risks. So far, however, the measures taken look quite modest. The cautious approach is understandable (nobody in Beijing wants another real estate bubble to develop) and China’s financial resources are not unlimited, so quick, decisive improvements probably cannot be expected from these measures.

EU takes a stance on Chinese auto exports

If domestic demand from households (and many companies) is not available as a growth driver, one clear option is to offset this with higher exports. And precisely this is causing more and more concern in the USA and in the EU, due to worries about their own companies as a result of cheap imports and Chinese subsidies. At least, this is the official rhetoric behind the latest announcements by the EU. Following in the USA’s footsteps, the Europeans will now apparently also impose high import tariffs on Chinese electric vehicles. Similar to the case in the USA, however, this step will mainly affect future Chinese exports, because electric cars (and indeed motor vehicles in general) from China have so far been quite a rarity in both the EU and the USA. One did not have to wait long for Beijing’s reaction. China will likely respond with countermeasures, for example against European vehicle manufacturers.

China surges towards technology leadership

At the same time, the example of electric cars underlines the extent to which the situation has changed over the last ten years. China has moved away from being the world’s cheap workshop, whose exports were generally very gladly seen, to being a real competitor or even a world leader in many forward-looking technologies, such as batteries, electric vehicles, solar panels, and other “green” technologies.

While the claim that with this China is exporting its economic problems to the rest of the world is not completely without basis, it is also not completely correct as a general statement. For many years, Beijing was criticised for overly lax environmental standards and excessively high emissions of greenhouse gases. Now, China has made massive investments in this field and has also trained a huge pool of engineers, scientists, and professionals. Certainly, one cannot criticise the Chinese for not wanting to harness this know-how and the production capacities that have been created on the domestic market alone.

Chinese subsidies are not the only problem and are not even the main problem, but rather the fact that the country has been able to build up a highly modern, strongly automated automotive industry from scratch over the last 20 years, and that this segment of the Chinese economy is able to challenge the incumbent market leaders on a cost basis even without state subsidies, and has at the same time broadly managed to catch up to these leaders in terms of quality and technology.

Equity markets: recovery takes a break

The equity markets in China rebounded strongly after the end of February, in particular H-shares listed in Hong Kong. However, this recovery then stalled from mid-May and the indices slipped 3% to 8% lower from the new annual highs that they had previously reached. Nevertheless, for May as a whole Hong Kong still posted a gain of around 2%, while A-shares from the Chinese mainland only suffered a small loss of 0.7%. The valuations in many market sectors remain very low, both in comparison to their own long-term performance and in international comparison.

In light of the ongoing problems in the real estate sector, the sometimes strong and unpredictable regulatory interventions by the authorities in recent years, and the geopolitical risks (cf. trade conflicts and sanctions), China will likely continue to trade at a significant discount.