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Recession in China and its Impact on World Economy

  • Category
    Economy
  • Published
    2nd Sep, 2022

Introduction

China’s economy is slowing sharply, oscillating the fear of global recession. The second quarter expansion of 0.4 percent is the weakest performance since the initial coronavirus outbreak in Wuhan. The world could soon be on the brink of a global recession.

State of China’s Economy:

  • Meagre Expansion: China’s economy grew at the slowest pace since the start of the COVID-19 pandemic in the second quarter. Its economy expanded just 0.4 percent year on year between April and June.
  • Low consumer spending: The lockdowns across the country have stifled industrial production to below market expectations resulting in consumer spending.
  • China’s non-manufacturing PMI, which tracks the construction and services sectors, decreased to 53.8 from 54.7 the previous month, showing slower growth in those parts of the economy.
  • China losing its edge: 60% of companies and 82% of manufacturers now report their production slowed during the present outbreak due to a lack of employees, inability to obtain supplies, or explicit factory halts resulting from the lockdowns.
  • Impact of the Russia-Ukraine conflict: China is an export-driven economy, so the supply chain disruptions due to the Russia-Ukraine war have added to its challenges.
  • The turmoil in Chinese markets has sparked debate among some economists over the possibility of a “balance sheet recession.”
  • Zero-tolerance policy towards Covid: China has locked down key industrial cities, which has interrupted industrial growth.

What is a balance sheet recession?

  • It is used to describe a situation in which household and business assets collapse in value. This severely damages their balance sheets, forcing them to save more while consuming and investing less, in turn causing an economic contraction.
  • Economists argue that balance sheet recessions are particularly hard to recover from. In these events, monetary policy becomes largely ineffective, as those with precarious balance sheets refuse to borrow money, no matter how low-interest rates are.

 Signs of global Economy looking gloomy:

  • In an update of the World Economic Outlook, said that the economic prospects had darkened significantly in recent months.
  • The IMF downgraded its global growth forecasts from its April projections, predicting that output will fall to 3.2% in 2022, from 6.1% last year.
  • Inflation is also rising more rapidly and broadly than the IMF anticipated earlier this year. It now expects prices to rise 6.6% in rich countries and 9.5% in emerging markets and developing economies.
  • Growth is expected to slow even further next year as central banks around the world raise interest rates in an effort to tame inflation by cooling their economies.
  • According to the report, the likelihood of a global recession is rising. It said the probability of a recession starting in one of the Group of 7 advanced economies was now nearly 15%, four times its usual level.
  • Companies earning taking the hit: Companies like Apple has warned of earnings hit of up to $8 billion from COVID-related supply disruptions; General Electric reports that lockdowns are suppressing demand as well as causing the supply-chain problem.

Fear of China slipping into Recession:

  • International Monetary Fund recently lowered its China GDP growth forecast for 2022 to 4.4%, well below the government's target of about 5.5%.
  • Tourist spending was down 43% from the same period last year, according to the Ministry of Culture and Tourism.
  • The services sector of China's economy plunged to 36.2 in April (below 50 indicates contraction). The impact is considerable, as the services sector accounts for more than half of China's GDP and over 40% of the country's employment.
  • Shrinking Manufacture Sector: China's manufacturing sector is shrinking; it appears that the world's second-biggest economy may have gotten smaller. The official manufacturing purchasing managers' index (PMI) fell to 49.0 in July from 50.2 in June, China's National Bureau of Statistics.
    • Indexes tracking output and new orders fell during July, with the sharpest contraction in activity coming in energy-intensive industries, such as petrol, coking coal, and ferrous metals.
  • People’s Bank of China has cut Interest rates: It has cut its repo and prime lending rates to stimulate credit and demand.
    • It was an unexpected move (given the necessity of maintaining price and financial stability) and it implies that the central bankers believe the Chinese economy is in a worse state than it appears.
  • China Loses Its Appetite for Imports: China’s appetite affects the rest of the global economy most directly through the prices of commodities, especially industrial metals. These are clear signs of weak Chinese demand.
  • Dipping Yuan: The yuan is near its weakest in two years and down more than 5% against the dollar over the last 12 months.

Long-Term Impact:

  • Impending Global Recovery: China’s control of the pandemic and restarting of its industries has played an instrumental role in the post-pandemic global economic recovery.
    • The Chinese economy falling into systemic risks could lead to the overall loss of momentum in the global post-pandemic economic recovery.
  • Declining Investments: Beyond a raised risk for short-term earnings miss, there may be a risk that global businesses slow or stop investing in China over the longer term.
    • Over the longer term, any extended disruption to consumer spending and business output is a risk to China-exposed companies.

Signs of Hope for China:

  • High cost of exiting the Chinese Market: There is a high cost associated with businesses abandoning their Russian operations, such as the $5 billion reported by Shell. A step back from China would probably entail much greater costs, given how deeply integrated China is in the world's supply chains and as a consumer market. So, the answer is not affirmative.
  • Major Companies continue to invest: the U.S. and European business investment in China grew steadily over the past decade, even during the height of President Trump's trade war with China.
    • China's inbound foreign direct investment in 2021 rose by a third, reaching a new all-time high of USD 334 billion. Major manufacturers, like Tesla, Ford, Nike, and Apple increased their investments, attracted to China's growing market and unmatched production competencies.
  • China's export industry continues to dominate: The waves of global COVID infections in 2020 and 2021 saw other countries that compete with China for export business suffer output gaps; China won more business as the government found ways to keep factories running.

How will a recession in China can affect other nations and the global economy?

  • A recession or a slowdown in China is going to leave an impact on the global economy. It was expected that it will contribute significantly to global economic revival from the pandemic. It accounted for about a fifth of global trade before Covid.
    • Therefore, anything close to a recession in the Chinese economy is going to have a spillover effect, pulling down global economic prospects.
  • China is a key player in the global supply chain, being a large supplier of critical chemical and industrial intermediates and consumer goods, from electrical equipment to plastics and toys to the developed world. It is also a global manufacturing hub for consumer goods and electronics. A Chinese slowdown can impact global trade in all these products.
  • On the flip side, China is also a significant consumer of commodities ranging from petroleum products to iron ore and copper. A slowing Chinese economy can thus cool global inflation.

Impact on India:

  • India depends majorly on imports from China including smartphones and automobile components, telecom equipment, active pharmaceutical ingredients, and other chemicals.

Thus, slowing the Indian economy will have an impact on India’s consumer market and infrastructure development. Any disruption in Chinese supplies can create shortages in these industries.

  • India’s iron ore exports, much of which are headed to China, could also see an impact if the crises in China trigger an extended slowdown in the Chinese real estate market.
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