China’s GDP in the first quarter of the year has surprised nobody, but the devil is in the details. Local retail sales continued to fall in March (-16%), marginally better than during the peak of the Covid-19 outbreak in January and February. The continuation of the slump in domestic demand clearly stands out when compared with the return to production in March. In fact, industrial production hardly declined in March (1.1%) after a collapse in January-February. More importantly, the vanishing demand cannot be explained by external factors only. In fact, export growth in March was negative (-12.5%) but less than domestic retail sales.
At first sight, one could imagine that the reason for such poor domestic demand is panic saving, but labour market data offers a much gloomier picture, with higher unemployment and collapsing disposable income (-12.5% in real terms in the first quarter). One important consequence of the collapse in demand versus a rather resilient supply is growing deflationary pressure in the Chinese economy. In fact, CPI inflation has clearly decelerated and producer prices are already in negative territory, even after the shut-down of factories for a couple of months. Against that backdrop, China clearly has more room for monetary stimulus, but the question is whether monetary tools can push people to consume, which is what is needed. On the fiscal side, China has eased value added taxes and temporarily waived social security contributions, but it remains unclear how these measures may help increase disposable income, and push households to consume. There have been some actions on consumption vouchers by some provinces but they have not been generalized yet. Furthermore, the collapse in retail sales is so widespread that the Chinese government may have to start thinking about putting money directly into households’ pockets, in the form of helicopter money or perhaps more targeted measures, given the size of China’s population and the very uneven income distribution.
Moving forward, the worst of the coronavirus contagion might have already passed in China, but the economy will still be under pressure in terms of how to resume consumption demand, which clearly requires positive growth in disposable income. Besides, two more challenges come to mind: plummeting external demand and deflationary pressures, which are obviously interconnected. Covid-19 seems to have pushed China back in its efforts to rebalance its economy towards a consumption-based growth model. This will be even harder if the government decides to jump on what it has long been able to deliver fastest, namely an infrastructure-led stimulus. Under the hypothesis that the world will continue to be locked down, or close to that, for the remainder of the second quarter, at least, the risk of China’s return to an investment-led growth model is high, with short-term winners on the commodity space but with long-term losers globally. A more unbalanced growth model, fed by ballooning debt, does not serve China well, nor the rest of the world.