China’s July Jitters become a Summer Slump

First read on August data suggests China’s economy slowed further, particularly in services.

By guest author Nathaniel Taplin from the Wall Street Journal

Caption and graphic courtesy by the Wall Street Journal

It has been a difficult summer for the world’s second-largest economy—a fact fully confirmed by `China’s official August purchasing managers’ indexes, released Tuesday. The big question now is how Beijing will respond.

The economy needs more support to avoid a steeper fall in growth, but that may be difficult to engineer without easing restrictions on the critical real-estate sector. Regulators are determined to prevent another sharp rise in leverage.

The reason for the vertiginous drop in the services sector index, from 52.5 to 45.2, is already well known: Efforts to contain the Delta variant outbreak originating in Nanjing hammered tourism and shut down some important cities in the country’s eastern economic heartland. With the outbreak now apparently under control, a strong rebound is likely in September—although consumer hesitancy, a tough labor market for young people, and the damage to household balance sheets from last year’s spring shutdowns will continue to prevent a full recovery to the pre-2020 trend.

But the weakness wasn’t confined to services, which tend to be most vulnerable to lockdowns. Factories’ new export orders fell to their lowest level since June 2020. And overall new orders fell through the 50 point mark separating expansion from contraction for the first time since the dark days of February 2020—though just barely.

That latter dip probably has a lot to do with the struggles of the property sector. Broader August economic data isn’t available yet, but property investment in July rose only 1.4% year over year, the smallest gain since March 2020. Curbs on property developer leverage are starting to bite, and bite hard. Output growth in heavy industrial products tied to real estate has also taken a dive in the past few months, although some of that is related to Beijing’s efforts to cap steel output at 2020 levels this year. Infrastructure investment has also weakened.

One bright spot is that this summer’s creep upward in some bank funding rates, such as the six month AA-minus negotiable certificate of deposit, has ebbed. That may be due to fading worries over the fallout from a potential default of Huarong, the country’s biggest bad-debt manager.

Still, with exports looking softer, housing investment in retreat and credit growth still on a firm downward trend, it is hard to imagine the economy stabilizing without extra help—even assuming a limited consumer rebound in the fourth quarter. If government support isn’t forthcoming soon, investors should brace for a weaker than expected Chinese economy in early 2022.