What is happening to the Chinese economy?

What is happening to the Chinese economy?
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Uncertainty around the fate of a large and heavily indebted Chinese property conglomerate, Evergrande, spooked equity markets at the end of September and prompted many market participants to question whether the much-discussed potential for the country to drive investment returns in the coming years continues to hold true. 

The scale of the company’s debts and the potential for it to destabilise the wider financial system prompted many investors to conjure images of a 'Lehman moment'; a reference to the collapse of Lehman Brothers, a US bank that precipitated the global financial crisis.

But after an initial and sharp market sell-off, global equities swiftly recovered, and even when Evergrande missed a debt repayment, this did not seem to negatively impact sentiment towards global equities.

George Lagarias, chief economist at Mazars Wealth, says: “If the market went back up because it was taking a view on the Federal Reserve monetary policy decision, I would be a lot more comfortable with that than the market deciding to rise because Evergrande was sorted. There is just so much we don’t know about it.” 

Silvia Dall’Angelo, senior economist at Federated Hermes, is among those who do not believe the problems at Evergrande will pose a risk to financial stability globally, but says events with the company could pose a threat to global economic growth. 

Dall’Angelo says: “In China, the Evergrande saga is still front and centre, with policymakers facing the challenge of reining in imbalances (including rising debt, bubbly prices and excessive risk-taking in the property sector), while also avoiding contagion risk and sharp repercussion on the growth outlook. The base case is that Chinese authorities will manage an orderly dismissal of Evergrande, making sure the goals of systemic stability and ‘common prosperity’ are preserved.”

Simon Edelsten, global equity fund manager at Artemis, says, despite its size, China is a relatively small part of economic demand for most companies, but the issue is on the supply side of the economy, and if China were to face a period of economic disruption, this would have consequences for the wider world. 

The middle-income trap  

While China's total GDP places it second in the world, its GDP per head of population is about $8,800 (£6,500), which is below the global average and puts China 86th in the world by that measure.

The danger for investors focused on China, or with portfolios heavily predicated on China growing swiftly, is that the economy becomes stuck in what the World Bank defined in 2006 as the “middle-income trap”.

This occurs when an economy moves from being – relative to the rest of the world – poor, to being in the middle of the income range, but is then unable to progress to being a 'rich' country.

The World Bank says only 15 nations in history have escaped the middle-income trap. 

Countries typically become middle income as they move from being predominantly agriculture-based to being the manufacturer of low-cost goods for export. 

The challenge this poses for an economy's development over the long term is that as a country exports more, the value of its currency would be expected to rise, and this creates domestic inflation and more liquidity in the economy.