ADRIAAN PASK: What next for China?

For decades, China has been the driving force behind global economic growth. Population growth and cheap labour, combined with government spending on infrastructure and prodigious  exports have served as major growth drivers. 

But in recent years, China has transitioned from relying  on excessive government spending for economic growth to prioritising consumer spending. But concerns are now emerging regarding the sustainability of its rapid economic expansion, especially considering high levels of debt (particularly among corporates and local government) and deteriorating demographics.​ 

Though government debt is consistent with global patterns in the aftermath of the pandemic, the alarming part is that corporate debt now stands at more than 150% of China’s GDP. ​

Worse, much of household wealth in China sits latent in its residential property values — a sector that is currently facing material debt challenges. ​

On the demographic front, the labour market is ageing, resulting in reduced labour force participation, while productivity appears to be in  structural decline. Youth unemployment in China is yet another problem, having risen 4.6% so far this year to 21.3% now, while the country recorded its first population drop in six decades in 2022.

Some reports suggest that China’s population could plunge from 1.4-billion now to just 488-million by the end of the century.  ​ 

Let’s focus on population decline to try to contextualise the numbers. The average mortality rate in China is 0.74%. An equivalent birth rate is required to maintain population size. But China’s current birth rate is only 0.68%, hence the decline in population size. 

For the population to fall 65% by 2100 it would need to decline 1.4% a year over the next 77 years. To offset this,  a population growth rate in excess of 1.4% would be needed each year. Any shortfall will require  increased consumer or government spending, inflation, exports, tax cuts or accommodative policies to counterbalance the negative effects.​  

Investors were previously willing to look past the risks facing the Chinese economy because the booming middle-class population, combined with economic modernisation, development and diversification were considered enough to bulldoze any challenges on the road to super-economy status​.

Yet a falling population and declining productivity are not easy challenges to overcome. These issues compromise the initial investment case for China, which was premised on very high levels of economic growth for decades to come due to scale advantages.​

There is no doubt there are both risks and opportunities,  but identifying risks is the easy part. The more important and challenging component is figuring out the likely impact down the road.​ The market seems to suggest that a debt crisis is not unlikely. Typically, these events can set back markets north of 40%. But if Chinese equities have already fallen 40%, and China’s real estate sector is down about 80% (both from prior peaks), is the risk not reflected in the price already? ​ If a broader debt event is to unfold, naturally markets will sell off, but therein lies the potential opportunity.

As for population shrinkage, it’s difficult to think that Beijing won’t respond to counteract this in the next 77 years. If history is anything to go by, there’s no  lack of willingness to assert policy to influence demographics.

While it would appear that stock prices in China already reflect a significant amount of bad news,  there is still a lack of confidence in prospects for the Chinese economy, which prevents any adjustments or improvements to forecasts. 

* Pask is chief investment officer at PSG Wealth