Economic momentum falters over Q2

After a relatively strong start to the year, China’s economy lost momentum in the second quarter of 2024. Real GDP growth slowed to 4.7 percent in Q2, down from 5.3 percent in the previous quarter. The economy is struggling with weak consumption and the ripple effects of the government-led crackdown on the bloated real estate sector. It suffers from low confidence among investors and households alike. The CNY/USD exchange rate has fallen to levels last seen in 2008, and the economy remains on the verge of deflation. Despite these many problems, China’s leadership is reluctant to roll out meaningful stimulus packages. Instead, economic policies are fully focused on establishing a new growth model centered around innovation and manufacturing. 

China's leadership probably anticipated a more favorable economic environment when it chose mid-July for the Third Plenum, a major meeting of the CCP’s Central Committee which will outline economic policy for the next decade. Instead, weak economic growth has caused growing tensions within China’s middle class, who are facing poorer prospects due to the real estate crackdown’s impact on key asset values and a weak labor market. Local governments are also feeling the strain as tax collection remains weak, further pressuring their finances.

Two crucial questions are how far the awareness of economic weaknesses extends up the chain of command and, more importantly, how much sympathy President Xi Jinping has for middle class economic woes. The leadership seems likely to stick to its current path, despite increasing pressures. Significant stimulus to boost growth appears unlikely. Instead, the government is expected to reinforce its narrative that the country is on the right trajectory.

Restoring confidence among the middle class, as well as within parts of the private sector and foreign companies, will likely rely on rhetoric rather than substantial policy changes. There is no reason to think Xi Jinping will retreat from his signature policies of a stronger role for the Communist Party in guiding the economy and prioritization of manufacturing and innovation. Both are seen as crucial to reaching the medium-term objectives the CCP has set for 2035, and hence are unlikely to be impacted by short-term economic troubles.

China’s new growth model, with its emphasis on channeling resources to innovation and technology, also risks further pushback from trading partners. China’s trade surplus is heading for another record this year, which will provoke stronger responses from the European Union and the United States. The EU is beginning to address the growing challenges posed by China’s manufacturing sector. The lead-up to the US presidential election is likely to surface heightened tensions over trade imbalances and technology access.

Looking ahead, China’s economy faces more headwinds in the second half of 2024. The government's current approach may need reassessment to address the underlying economic challenges effectively if growth fails to improve. However, its focus is on long-term goals and a new growth model, making substantial short-term adjustments in economic policy improbable. Nonetheless, selling China’s new growth model to its middle classes is an uphill battle, with uncertain consequences ahead.

Macroeconomics: Q2 GDP growth disappoints as government holds back on stimulus

• China's GDP growth slowed to 4.7 percent in Q2, the lowest growth since the last quarter in 2022 when China was still suffering Covid lockdowns (see exhibit 1). The economy faces significant difficulties, largely due to the downturn in the real estate sector and persistently weak consumer spending, and deflation remains a threat. 
• Crucial drivers of growth started to slow over Q2, stoking pressures on the economy. Manufacturing growth continues to outpace overall GDP growth, yet it dropped back to 6.2 percent in Q2 from 6.4 percent in Q1. Similarly, growth in IT services and software slowed to 10.2, down from 13.7 in the previous quarter. 
• Quarter-on-quarter growth slowed to 0.7 percent in Q2, down from 1.5 percent in Q1. This points to momentum weakening further in the second quarter as the economy lost steam, especially in June.