Over the last three months, Chinese policymakers have delivered their latest series of stimulus packages to inject new life into their struggling economy and boost share prices. However, high debt levels, overinvestment, an unresolved property bubble, underwhelming domestic consumption and international trade pressures are contributing to structural weaknesses in China's economy that cannot be addressed through temporary fixes.
Debt and overinvestment have caused productivity decline and deflation. With debt levels soaring to 350% of gross domestic product (GDP), each yuan injected into the economy yields diminishing returns. Adding to the challenge is overinvestment of nearly 45% of China's GDP funneled into projects that now face declining domestic demand. This flood of excess capacity has led to deflationary pressures in both producer and consumer prices.
China's property market, once an anchor of the country's wealth, has become a liability, with more than 60 million empty units.1 Property represents about 60% of a Chinese family's net worth, compared to 27% in the U.S., eroding consumer confidence. Efforts to boost domestic consumption have largely fallen short. Unlike in the U.S., where lower interest rates typically encourage consumption, the Chinese are reluctant to spend, concerned about falling property values and the absence of a strong social security net.
Trade and surplus challenges
China is increasingly following in the footsteps of manufacturing giants like Germany and Japan and relying on exports to sustain growth, without a commensurate domestic market to absorb the production. In China, stimulus increases supply rather than demand, leading to excess capacity, which it exports. This export-dependent strategy has led to an accelerating trade surplus, creating significant tensions.
Increased trade and investments have been at the core of Beijing's external policies. But trade disputes have led to decoupling of the two top economic powers, with Chinese shipments to the U.S. dropping from 21% of its total exports in 2000 to 16% as of December 31, 2023.2 Instead, Beijing has largely retained its global market share by redirecting exports to Europe and emerging markets. Shipments to developing economies have surged from 16% of total exports in 2000 to 44% in 2023.
Since the beginning of 2022, China has experienced significant capital outflows of nearly $300 billion and a 70% decline in foreign direct investment (FDI),3 especially in strategic manufacturing industries such as semiconductors, telecommunications and pharmaceuticals.Stimulus efforts insufficient
Since the global financial crisis, China has rolled out five major stimulus packages. Each intervention has provided a short-term market lift coinciding with a cyclical boost to growth, but as evidenced in the last cycle of 2022, such effects are beginning to wane. Japan's "Lost Decade," beginning in the 1990s, provides a sobering parallel. Following its economic peak in the 1980s, Japan experienced long-term stagnation interspersed with brief market rallies that averaged 45% within a downward market trend. China's market, under the influence of stimulus packages, has similarly rallied five times in recent cycles by about 35%, making lower highs and lower lows.4
Bottom line: We believe there are no quick fixes for China's economic quandary. Only a complete debt restructuring, followed by bank recapitalization and government-led redistribution will drive meaningful, positive change. It will no doubt be painful. Until China addresses the root issues—excessive debt and inefficient investment—stimulus measures may provide fleeting relief but will remain mere band-aids.
1 Bloomberg Economics.
2 Morgan Stanley Investment Management and Haver Analytics.
3 Statista, International Monetary Fund.
4 Morgan Stanley Investment Management, Bloomberg.
