Letter from China 2 : The economic challenge facing Beijing

  • April 15, 2020

This is the second article of an exclusive series of reports from inside China that GroundXero would publish in the days to come. 


The novel coronavirus pandemic will extract a steep cost on the world economy. The global recession the disease outbreak will inevitably bring about will be far deeper, wider and more protracted than the one following the 2008 global financial crisis. True, many governments have vowed to boost their economies with unprecedented monetary and fiscal stimulus — even though quite a few of them already have massive public debt — they can only hope that their moves will be able to prevent an economic collapse.


The United States, the worst hit country by the pandemic, is already struggling to keep its economy afloat, thanks to the fear the virus has inflicted among the general people. The European Union, already weakened by the exit of the United Kingdom from the economic bloc, is fighting a desperate battle to maintain economic and social order, as its major economies — Germany, France, Italy and Spain — have been overwhelmed by the rising numbers of infections and deaths (although the death toll in Germany has been comparatively low).


By April 12, 2020, the United States alone had reported more than 560,000 confirmed cases of novel coronavirus infections and over 22,000 deaths. In Southern European countries such as Italy and Spain the death was almost 20,000 and over 17,000 from more than 156,000 and 166,000 confirmed cases respectively. Which means the death tolls in the US, Italy and Spain have been relatively high. France too is reeling under the impact of the pandemic, accounting for more than 95,000 cases and over 14,000 deaths.


China death toll relatively low


In China, where the virus was first detected in Wuhan in Hubei province, despite the infections being as high as 82,000, the death toll has been relatively low: 3,300 on April 12. By contrast, the death toll in the UK on April 12 was more than 10,000 from over 84,000 infections.


Part of the reason for the relatively low death tolls in China and Germany (more than 126,000 cases with over 2,900 deaths), and that in South Korea (more than 10,500 cases but only 217 deaths) and Japan (7,255 cases but only 102 deaths) can be attributed to their robust public health systems.


This shows that having well-oiled industrial and agricultural sectors and a high economic growth rate alone are not enough to have a healthy economy that can withstand the impact of emergencies such as natural disasters, pandemics and global economic volatility. For that, it is equally important for an economy to have expansive public welfare schemes in place, including a vigorous public health system, an effective social welfare program for all workers, worker-friendly laws and a public-oriented education system.


Yet, despite having a robust health system, a sound education system and several social welfare programs in place, China has been feeling the devastating impact of the pandemic on its economy. Most of the early forecasts were moderate, but according to global financing services firm JP Morgan, China’s economy will shrink by up to 40 per cent in the first quarter (from January to March) of 2020. For the US, international investment banking, securities and investment firm Goldman Sachs has predicted a 24 per cent reduction in the second quarter, while Morgan Stanley has forecast a 30 per cent drop. Worse, over 1 crore Americans had filed for unemployment benefits from the last week of March to the first week of April.


Coming back to the pandemic, it needs to be remembered that, despite some improvements in recent years, many countries have not been able to meet even the basic requirements for compliance to the International Health Regulations. And several outbreaks, including the 2014 Ebola outbreak in Western Africa, have exposed the gaps in timely detection of diseases, availability of basic medical care, contact tracing, quarantine and isolation procedures, and preparedness outside the health sector, including global coordination and response mobilization.


Such gaps are more evident in resource-limited economies and have posed a big challenge even during local outbreaks, with grave implications for what may happen during a widespread epidemic.


Virus is unpredictable, resilient and ruthless


And that is exactly what has happened now, especially because the novel corona virus is resilient, ruthless, and unpredictable with no regard for race, nationality, ideology or wealth. Yet, unfortunately, it is the poor, most vulnerable and helpless who are least responsible for spreading diseases such as COVID-19 across the world, that by far are the biggest victims of pandemics. By April 12, the corona virus pandemic had already infected more than 1,850,000 people and killed over 114,000.


It has overwhelmed healthcare systems, forced hundreds of millions to remain confined to their homes and halted economies. And it is not backing down.


The just-in-time world economy cannot survive more than two months of lockdown before its “Minsky moment” — when investors start panic selling, a boom becomes a crash, and bubbles go bust. Stock markets across the World, including Western economies, have already plummeted, although they have shown signs of recovery thanks mainly to governments’ efforts to keep the economy moving. In the US, the Dow Jones Industrial Average, even with its uptick, experienced one of its worst months since the Great Depression of the 1930s.


Although China’s stock market has so far endured the lockdown in Hubei province and economic slowdown across the country without a sharp decline — mainly because it had already suffered from the trade war with the US — vast amounts of wealth have been destroyed in China. In the first two months of this year, for example, China’s industrial value-added for large and medium-sized enterprises declined by 13.5 per cent year-on-year; urban investment on fixed assets plummeted by 24.5 percent and total retail sales dropped 20.5 per cent. In contrast, in December 2019, they had grown by 6.9 per cent 5.4 per cent and 8 per cent, respectively.


Reviving production and consumption vital to China


No wonder China, like many other major economies, now believes that while lockdowns are essential, strong action to revive production and consumption is equally important to contain the pandemic and also keep the economy rolling. Which means China may implement active monetary and fiscal policy in the short term. But since such measures have only limited potential for globalized economies, even the US Federal Reserve’s rapid move to cut interest rates and promise to pump trillions of dollars failed, to a large extent, to stem the stock market collapse.


The Chicago school of economists, originally led by the late Milton Friedman for whom China has high regard, realized that fiscal measures could have a stronger impact on “reviving” the economy during emergencies. No wonder the US Congress approved an unprecedented $2 trillion economic package to stabilize the US economy — which includes direct payments to taxpayers, unemployment benefits, and a $500 billion fund to help businesses — which eventually halted the US stock market’s decline.


But since the spread of the virus is yet to be effectively contained outside China even after two and a half months, its negative impact will be massive on the world economy. And if the global financial market declines sharply, major central banks including the US Federal Reserve are expected to launch a new round of loose monetary policy aimed at stabilizing market expectations and arrest the economic decline.


However, in spite of the possibility of many countries further loosening their monetary policy to overcome the impact of the pandemic, the renminbi is expected to remain stable. The Chinese currency could even rise slightly against the US dollar.


Beijing enjoys certain economic advantages


Besides, although the People’s Bank of China, the country’s central bank, has cut the interest rate to increase liquidity, its loose monetary policy is moderate compared with those of the European Union and US central banks. The spread of the interest rate of China and the US’ national debt show the difference in the two countries’ loose monetary policy. For instance, the 10-year return rate on Chinese government bonds is 2.6 percent, while in the US it is only 0.8 per cent.


Besides, international financial capital shows an inclination of flowing into the Chinese market. Even at the height of the outbreak in China, foreign financial institutions raised their investment in the country’s bond market. By the end of February, for example, foreign institutions held Chinese bonds worth 2.28 trillion renminbi ($321.16 billion), an increase of $12.82 billion from the end of 2019. The trend of foreign capital inflow into China is expected to continue with Chinese enterprises gradually resuming production now that China claims to have virtually contained the spread of the virus at home.


These factors are conducive to the Chinese currency remaining stable, even slightly rising against the US dollar.


Declining imports and exports not a good sign


But the decline in China’s current account surplus, and a possible current account deficit, may have a negative impact on the renminbi’s exchange rate. Data released by China’s National Bureau of Statistics in February show the country’s total import and export value in the first two months of the year was $592 billion in US dollar terms, a decline of 11 per cent year-on-year. While China’s exports fell 17.2 per cent to about $292 billion, imports declined 4 per cent to about $300 billion. In real terms, the trade deficit was $7.09 billion in January-February this year, compared with a trade surplus of $41.5 billion in the corresponding period in 2019.


Due to the pandemic, Chinese exports to major economies such as the European Union, the United States, Japan and India, could further decline. Since China is the “world’s factory”, it could also face far greater problems than many other economies if there is a major disruption in the global industrial chain, which is based on the so-called new international division of labor — that economic globalization propagators have promoted to exploit the people of former colonial and semi-colonial, and now dependent countries.


Plus, the fact that China has to expand the purchase of US commodities according to the recently signed “phase one” Sino-US trade deal to end the trade war will make it even more difficult for China to maintain, unlike the past, a high current account surplus. Since China’s high current account surplus has been a major reason for the Chinese currency’s stability against the US dollar for years, the impact of a current account deficit on the renminbi’s exchange rate could be substantial.


For China, creating jobs remains a major problem 


The other major problem China faces is providing employment for new college graduates. This year, more than 87 lakh new college graduates will enter the job market. Across the globe, especially in major economies, such graduates face the greatest difficulty in getting an “ideal job”, not least because for companies, the cost of recruiting college graduates is comparatively high as most of them follow a trial-and-error hiring process and the new recruits have little or no working experience. And when external risks increase, due to crises such as the coronavirus pandemic, the companies become even more reluctant to recruit new graduates.


In China, new college graduates are likely to face even more serious challenges in getting the right job this year when, despite the declining market demand for college graduates, a record 87.40 lakh students — an increase of 4.8 per cent year-on-year — are expected to pass out of colleges. Especially, according to a top Chinese job search engine, from August 2019 to February this year, the number of new posts for college graduates published online declined 4.4 per cent year-on-year.


Perhaps, the Chinese government might offer new college graduates some support to get a job. It could, for instance, initiate a special employment action plan for college graduates this year to help them get jobs, enroll for master’s degree courses or take part in special training programs, in order to prevent a sharp rise in unemployment numbers.


There is also a possibility that the Chinese government will implement diversified and flexible employment models, such as promoting the “sharing-employee” business model — that is, two or more companies “sharing” or hiring the employees of one company introduced by some enterprises, in particular in internet- and IT-facilitated businesses, to reduce their human resources cost — to ensure more college graduates are recruited this year.


The Chinese government could also consider establishing a national compulsory service system and implementing a national compulsory service plan, making it mandatory for college graduates to work in designated regions, industries and organizations for one full year before seeking jobs in cities and companies of their choice.


Move to attract foreign capital and enterprises


Moreover, China is gradually reviving economic activities and taking measures which it says will create a better business environment for foreign enterprises. However, China faces many challenges in resuming normal economic activities, including creating more jobs, mitigating the loss incurred by the service industry (especially the hospitality sector), and helping many enterprises to access funds.


Pandemic a big blow to small and medium-sized enterprises


Small and medium-sized enterprises (SMEs) play a key role in boosting China’s economic growth, creating employment, improving people’s livelihoods and promoting innovation. SMEs comprise up to 90 percent of China’s domestic market players, and contribute to about 50 per cent of its tax revenue, 60 percent of GDP, 70 percent of technological innovation and 80 percent of urban employment.


As China is still fighting to effectively contain the coronavirus outbreak, the SMEs are encountering difficulties on both the supply and demand sides. In fact, there has been a large-scale decline in demand.


To prevent and control the spread of the virus, China imposed strict restrictions on the movement of people and vehicles, which reduced consumption demand, especially in the hotel, catering, transportation, tourism, retail and entertainment sectors. A huge number of SMEs are part of these sectors, and data show that the turnover of about 60 per cent of the SMEs will decline by more than 20 per cent, while that of 30 per cent will decrease by over 50 per cent.


The impact of the epidemic has been immense on the supply side, too. Due to the prevention and control measures, many people have not been able to return to work even after the extended Spring Festival holiday. According to rough estimates, about 70 per cent of the migrant workers in major cities such as Beijing, Shanghai, Guangzhou and Shenzhen had not returned to work till the end of March, which will have a serious impact on the traditional service sector and the labor-intensive manufacturing industry, which mainly consist of SMEs, for the rest of the year.


Since the SMEs find it difficult to resume normal operations in the short term, not least because of shortage of financing, their problems have increased. By the end of March, the operation resumption ratio of the SMEs was about 60 per cent. And if the SMEs cannot resume normal operations, their revenue will sharply decline, making it very difficult for many of them to survive as they cannot avoid paying for the costs of human resources and materials, and rentals.


The Chinese central and local governments are helping the SMEs by taking measures to address their raw material and transportation problems, and deferring the payment of their electricity, water and gas charges until the epidemic is fully contained, and exempting them from paying part of their social security fees, and granting them special loans. One waits to see whether such interventions would prove adequate in rejuvenating the SMEs in the long run.


Rising uncertainties: a matter of concern 


All this means the economic uncertainties for the Chinese economy have increased manifold due to the pandemic, particularly because Chinese exports are expected to fall drastically owing to falling global demand.


The impact of the coronavirus pandemic is likely to be much greater on the global economy, and therefore the US and Chinese economies because, unlike in the wake of the 2008 global financial crisis, Washington and Beijing today are at loggerheads. Following the 2008 global financial crisis, the world economic recovery got a major boost from Sino-American cooperation, which supported individual stimulus measures — quantitative easing in the US and large-scale fiscal stimulus in China.


But since the global public health crisis has erupted at a time when Sino-US ties — and more broadly global cooperation — are at their lowest point in decades, the situation looks grim for the world economy and by default the US and Chinese economies.


There is no denying the fact that China today occupies a central position in the global supply chain — and to a large extent an increasingly important position on the global demand chain. But the Donald Trump administration is not ready to accept that. And hence the economic and political moves made by the US, which can still influence global policies, can create major economic problems for the rest of the world, especially China which has become the real target of the US’ global political and economic policies.


Yet the US seems hell-bent on proving that the pandemic will weaken China’s position in the global supply chain. The fact is that even if more regionalized and diversified supply chains can reduce risks, China has considerable competitive advantages in many areas, such as electronics, machinery and equipment manufacturing. It cannot be replaced, not in the near term at least.


However, instead of weakening China’s position on the global supply chain, US efforts have only so far helped China to climb up the value-added ladder. For example, the Yangtze River Delta region and Guangdong province — which used to make garments and shoes, and assemble electronics for the global markets — have today become high-tech hubs, the city of Shenzhen in particular.


High cost of stringent steps to contain virus 


But China’s lockdown and other stringent measures have extracted a high economic cost, which could possibly amount to an 8-10 percent decrease in GDP in the first quarter.


To cope with that, China plans to follow through on existing infrastructure-investment plans — including building ultra-high-voltage power grids, intercity high-speed railways, and 5G networks  — as well as take other measures to support economic and employment recovery, including subsidies and tax exemptions. And with a fiscal deficit of less than 3 percent of GDP, China can afford to take such measures. Such investments could help China build on recent successes in high-tech sectors, including big data, artificial intelligence, the Internet of Things, and the industrial Internet.


Yet, in spite of possibilities, the cloud of uncertainty looms large over the Chinese economy, as its future prosperity depends not only on domestic demand and the smooth functioning of the Chinese market, but also the prospects of the global market and other economies. Despite the claim to the contrary, the Chinese economy still needs the world economy to perform well in order to ride on its success story. And the world economy, especially the economies of major countries, seems to be in the doldrums.


The author is a friend based in Beijing, who prefers to remain anonymous for obvious reasons.


Also read: Letter from China 1


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