China’s export engine, vital to maintaining the country’s growth target of around 5 per cent per year, is now threatened by signs of falling US demand, at a time when Beijing is also struggling to stimulate its own consumer economy.
Foreign sales have been a rare bright spot for China’s 17 trillion dollar economy over the last six months, helping it to resist pressure from weak domestic spending and a prolonged slump in the property sector.
After three months of acceleration, export growth in dollars unexpectedly slowed to 7% in July compared to a year earlier, data showed on Wednesday 07 August. On a seasonally adjusted basis, monthly export growth to the US fell slightly, according to Pantheon Macroeconomics.
However, a potential demand shock from the US could be difficult to contain, as the country remains the largest destination for Chinese exports by country, despite years of trade rancour and tariffs designed to protect domestic industries. There is also the risk that a US slowdown could send shockwaves around the world, reducing global demand for Chinese products.
A slowdown in the US would change the priorities of China, which took advantage of the resurgence of the US economy after the pandemic to leave domestic consumption in the background and instead relied heavily on external demand.
Now, however, a more adverse outlook for trade, which is stifling exports, could force Beijing to look inwards for catalysts to unlock future growth.
“For Chinese policymakers, the key thing is to defend their growth objective,” said Larry Hu, head of Chinese economics at Macquarie Group Ltd. “If China can no longer rely on export growth, they will turn to domestic demand.
What Bloomberg Economics says …
“The unexpected slowdown in China’s exports in July suggests that foreign trade – the mainstay of the recovery last quarter – may provide less support to third-quarter GDP. The result is particularly worrying given the weakening prospects for the US economy, highlighted by the recent jump in US unemployment.”
In the meantime, evidence has been mounting that the world’s largest economy is slowing down, which contributed to the fall in the world stock market this week and raised concerns that the Federal Reserve may have kept interest rates too high for too long.
What happens next will largely depend on how US consumers behave, as the labour market slows and sentiment remains weak.
The worst may be yet to come. A weaker than expected wage report last week, rising unemployment and an ever-increasing contraction in manufacturing all point to an unstable labour market.
The US now absorbs a smaller proportion of Chinese exports than it did at the start of Donald Trump’s presidency in 2017, with its 13 per cent share overtaken last year by the 27-member European Union as a whole. However, slower spending by American buyers would have repercussions around the world, reducing demand for Chinese products, from consumer electronics to clothing and machinery.
“Due to the slowdown in the US economy, threats of additional tariffs and the ongoing technological decoupling, China’s export-led growth strategy will be harder to realise this year,” said Kelvin Lam, senior economist at Pantheon Macroeconomics.
Economists at Goldman Sachs Group Inc. now see a one in four chance of the US falling into recession, increasing the probability to 15 per cent.
The consequences of a downturn in US consumption could be especially painful for emerging markets, where China has been strengthening its position. These repercussions could jeopardise the strategy promoted by President Xi Jinping’s government to diversify trade by sending more products to countries like Vietnam and Saudi Arabia.
The US sneezes
“When the US sneezes, emerging markets get a cold, if not pneumonia,” said Alicia Garcia Herrero, Chief Economist for Asia-Pacific at Natixis SA. “And China, at the moment, is increasingly dependent on the markets of the emerging world.”
Around 40% of China’s exports go to emerging and developing economies, compared to 33% in 2017, before the trade war with the US, according to International Monetary Fund data analysed by Bloomberg.
Another source of risk is the fact that China’s export share in the global manufacturing industry is increasing and now exceeds 30 per cent, according to Jing Sima, chief China investment strategist at BCA Research, who was interviewed by Bloomberg.
“This puts China in a particularly vulnerable position to a slowdown in global manufacturing due to the interconnected nature of world trade,” he said.
In addition, China’s large investments in manufacturing, coupled with subdued domestic demand, are exerting downward pressure on prices and resulting in overcapacity in some sectors.
Under these conditions, external demand has to compensate for the lack of capacity. China’s trade surplus rose to a record level in June, increasing the risk that its partners will step up efforts to protect their markets from Beijing. This figure decreased in July.
Recognising the risks to external demand, the Chinese authorities have been stressing the need to boost domestic consumption.
According to Bloomberg, last month the ruling Communist Party pledged to make consumer spending a higher political priority. And on Saturday, the government released a 20-step action plan to encourage more spending on services, although it offered few financial incentives to stimulate domestic demand.
Investors will be watching closely. If the government succeeds in increasing domestic spending, the local currency could be boosted, since higher domestic demand usually leads Chinese exporters to convert more foreign revenue.
“If we see better domestic demand, then we will most likely see the renminbi strengthen and Chinese bond yields will also rise,” said Macquarie’s Hu.
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