China reaction: downside risks resurface, growth target in question

Once strong supports to growth, now softening

Fixed asset investment (FAI) continued to lose momentum, slowing to 3.6% yoy year to date (ytd) in July, down from 3.9% in June. The growth for July alone is estimated at an annual 1.9%, a sharp decline from 3.6% in June. The primary drag was a significant slowdown in infrastructure investment, which rose by only 2.0% yoy in July, compared to 4.6% in June. Although investment in the manufacturing sector also edged down slightly, it remained relatively robust, growing by 8.3% in July, from 9.3% in June. Additionally, there was a notable contraction in investment in education, healthcare and culture, sports and entertainment in July, with declines of -8.6%, -15.6%, and -6.9%, respectively.

Industrial production (IP) eased in July, dropping to 5.1% from 5.3% in June, mirroring the weaker Purchasing Managers' Index (PMI) observed earlier in the month. High-tech manufacturing continued its strong performance, increasing by 10.0% in July, up from 8.8% in June. Production in the computer, communications, and electrical equipment manufacturing sectors saw a significant uptick, rising by 14.3% in July, compared to 11.3% the previous month. However, production in automotive manufacturing slowed further, with growth declining to 4.4% in July from 6.8% in June, dragging on headline IP for the first time since May 2022.

China’s economy managed to grow by 5.0% in the first half of the year, largely due to the support from non-property investment, which bolstered the supply side. However, FAI and IP have been decelerating in recent months, putting this year’s growth target in question. The sluggish issuance of local government bonds may explain the weakness in FAI, particularly in infrastructure, amid tight project scrutiny. The buoyant FAI in the manufacturing sector could be attributed to the recent equipment upgrading programme. While IP slowed less sharply compared to investment, concerns are mounting. With domestic demand growth remaining bleak, and external demand likely to be curbed by trade frictions and the fading impact of front-loading, the impact of rising excess production risks exacerbating overcapacity in the Chinese economy, adding further disflationary pressure.

Better reading in a single month does not change the bleak picture in domestic demand

Retail sales picked up slightly in July, growing by 2.7% yoy and 0.4% month on month (mom) (June: 2.0% yoy, -0.1% mom). While sales of goods rose to 2.7% yoy from 1.5% in June, catering sales slowed to 3.0% from 5.4% previously. Home appliances, which were supported by the recent trade-in programme, saw declines narrow to -2.4% in July, from -7.6% in June. Automobile sales fell by 4.9%, slightly better than June's 6.2% drop. Electric car sales, backed by the trade-in programme, continued to outperform, rising by 36.9% in July.

Despite the slight improvement in retail sales in July, the pessimistic outlook lingers. Although Beijing has shifted its policy focus towards restoring consumer demand since July, it may not be strong or direct enough to boost actual activity.

Worsening unemployment and property woes pressure consumers

The unemployment rate rose to 5.2% in July from 5.0% in June. Although official statistics do not fully capture the dynamics of the labour market due to their narrow coverage, they indicate a worsening situation. Additionally, a large number of A-share companies have reported reduced wages, and employment in the “gig economy” continues to rise, all pointing to a bleak labour market outlook. This will be a further headwind to household spending, weighing both on income growth and sentiment.

It has also been three months since the initiation of the house stock purchase programme. However, no local government has reported a completed purchase. Meanwhile, only 4% of the 300 billion Chinese yuan (RMB) re-lending programme from the People’s Bank of China (PBoC) had been issued by the end of June. With such a slow start, this programme has yet to have a material impact on the pace of property price decline, which fell by 0.6% mom in July in the primary market – the 14th consecutive monthly decline.

Downside risks become clear

Today’s weak activity data is unsurprising given the subdued PMI and credit data. However, it raises concerns as key growth drivers show clear signs of slowing down. A major catalyst to reverse the decline in property prices and consumption is not yet in sight, and downside pressure is squeezing external demand. With challenges in internal and external growth engines appearing to mount and an as yet insufficient response to boost consumer spending, the risk of demand-deficient growth period, pushing headline inflation into deflationary territory is rising. A broad-based slowdown lies ahead if policymakers do not respond in a timely manner.

However, based on recent official meetings and media communications, Beijing is likely to continue with an incremental policy approach for the rest of the year. We expect no more than a 20 basis points rate cut later this year, alongside increased but modest efforts to support the property market.