China’s economic growth came to a screeching halt in the first quarter of the year, due to the government’s measures to contain the Covid-19 virus. Macroeconomic indicators fell off a cliff and, for the first time since the cultural revolution in 1976, China’s economy contracted with GDP growth falling by 6.8. Despite signs of economic recovery in March, China’s economy is far from normal.
The effect of the shutdown is unprecedented. Previous crises over the past two decades, like SARS in 2002/3, the global financial crisis of 2007/8, and the stock market turbulences in 2015/16, pale in comparison to the current devastation.
Starved of revenue, industrial profits tumbled by 38 percent in the first two months with almost half a million companies reported to have closed. Small and medium sized enterprises (SME) are particularly vulnerable. They were already struggling for financing since the onset of the deleveraging campaign in 2018 and lack the credit lines that large businesses have. This has resulted in layoffs – and wage losses – in what is usually a key hiring season following the Chinese New Year.
Restarting the economy will be an uphill struggle
Restarting the economy will be an uphill struggle as the full scale of the simultaneous supply and demand shock unfolds. With the prospect of a massive global recession, the outlook is dim. The risk of further bankruptcies and defaults is likely to grow over the coming months.
The government has responded by announcing new stimulus measures on a daily basis. With fiscal policy aiming at shoring up demand and supporting struggling companies, the fiscal deficit ceiling could well rise to over 3 percent of GDP. Meanwhile, the PBOC has used all its monetary policy instruments to lower lending costs and ensure sufficient liquidity.
The aim of the stimulus measures so far has been to alleviate the immediate economic challenges. For now, the government is holding back from unleashing an all-out stimulus package – as it did during the 2007/8 global financial crisis – since this would wipe out the progress made over the past two years in reducing the buildup of risks in the financial system.
Compared to 2007/8, this crisis has hit China when its economy is in a very different state. It is already highly leveraged with GDP growth at much lower levels. Increasing infrastructure spending, as the government did in 2009, is not a solution this time, since the structure of the economy has changed with private companies and the service sector now playing a greater role.
More stimulus measures can be expected
The measures introduced since last year targeting the private sector, like tax breaks, reduction in red tape, and efforts to improve access to capital, all helped cushion last year’s slowdown. The expansion of such measures over the first quarter of this year are more likely to ease the immediate pain rather than provide a major boost in economic growth.
More stimulus measures can be expected over the coming months, but China’s government will not be able to defend GDP growth levels in the same way that it did in the past. Nor would it be wise to do so. Reaching the growth target of around 6 percent is now unattainable and the target may even be dropped, as PBOC advisor Ma Jun has suggested. What this all means is that during this global economic crisis, we cannot expect China to be the engine for growth.