China's Economy Is Growing Again, Sort Of

Further scrutiny of China's 3.2 percent GDP growth in the second quarter of 2020 still shows uneven, slow healing from the COVID-19 crisis that leaves the Chinese economy vulnerable to setbacks and shocks, even as the headline number suggests a slight recovery from the country's deep dip earlier this year. Risks in the second half of the year include a renewed virus outbreak, residual Chinese consumer caution and weak business investment in manufacturing plants and equipment, shaky global demand for Chinese exports, heightening tensions with the United States, and severe flooding currently in much of the country.

China's economic recovery in the second quarter was largely a supply-side phenomenon driven by industrial and state growth, with private demand continuing to lag. On its face, the 3.2 percent GDP increase (year-over-year) is a significant improvement from the 6.8 percent decline in GDP growth China reported in the first quarter, leaving output in the first half of year only 1.6 percent less than the same period in 2019. In particular:

Industrial output was up by 4.8 percent from a year earlier, with most of the growth in raw materials production, technology components, automobile production and energy.
Much of the increased domestic supply, however, went into inventories, which are accounted for in GDP data as investment. Retail sales continued to lag and were down by 1.8 percent — a progressively smaller decline from March-May, but still indicating depressed household consumption and residual consumer caution. Car sales also were down from a year earlier despite increased production.
Fixed asset investment overall fell by 3.1 percent in June, with private investment down 7.3 percent after falling for a fifth consecutive month. Investment by state-owned companies rose by 2.1 percent in June, much of it in infrastructure after successive falls in previous months. That indicates further a policy-directed growth increase that has yet to take hold privately.
Both exports and imports were up in June but the contribution to GDP from net exports shrank, with a small trade surplus of $46 billion and foreign trade down by 3.2 percent for the first half of 2020. Low prices for imported commodities, however, helped keep trade positive.

Looking ahead, unemployment in China continues to be a drag on consumption. The surveyed urban unemployment rate ticked down to 5.7 percent, but it undercounts the number of jobless by excluding migrant labor. Other data showed labor migration was down by 2.7 percent year-over-year. 1.73 million fewer jobs were also created in the first half of the year, with setbacks, particularly for younger workers.

The Chinese government's fiscal and monetary policies will likely remain accommodative, albeit with some new caution by the country's central bank. A recent stock market bubble, in which both the Shanghai and Shenzen stock markets rose by 14 percent in just two weeks in July, suggests credit market support might be contributing to asset price inflation, rather than supporting the real economy. Property investment, for example, was also up strongly in June by nearly 2 percent.

Further scrutiny of China's second-quarter GDP growth still shows an uneven, slow recovery from COVID-19 that leaves its economy vulnerable to setbacks and shocks.

At the same time, fiscal stimulus will be important, and while a debt crisis is unlikely, the Chinese economy's dependence on credit is still a risk. The Chinese central government's deficit this year is projected at only 3.6 percent of GDP, an increase from previous years to be sure. But borrowing and off-budget operations push Beijing's real deficit closer to 11 percent of GDP, and perhaps as high as 15 percent. The Chinese government dropped its formal GDP growth target for this year, which will help constrain increasing debt as provinces no longer have to meet artificial output goals with unproductive investment financed by borrowing. Though even so, China's debt-to-GDP ratio was nearly 317 percent in the first quarter of 2020, an increase from only 300 percent at the end of 2019.

China was the first in and was expected to be first out of the COVID-19 crisis, as its authoritarian system was able to impose massive lockdowns and monitoring systems to track and contain the virus, which has proven to be a challenge in other countries. Difficulties in returning the Chinese economy to normalcy is thus not encouraging for economic revivals elsewhere. China's current growth model is nearly universally known to require rebalancing away from the infrastructure-driven, export-led growth of the last 30 years and toward a more consumption-based economy, but that may be on hold and imply further structural slowdowns for China's economy going forward.