Could China Drag the World into a Global Recession?

Here’s a look at the five biggest economies in the world (as measured by total GDP), as of October 2022 according to the International Monetary Fund¹:

• United States: $25 trillion
• China: $18 trillion
• Japan: $4.3 trillion
• Germany: $4 trillion
• India: $3.47 trillion

A key takeaway from the above data is a clear one: the United States and China are the two most important determinants of global economic growth. In other words, as the U.S. and China goes, so goes the world.

For this reason, current issues in China should be high on investors’ radars. 2022 has been a challenging year for China for reasons we will review below, but recent events there have made these economic difficulties far worse. A strong growth outlook for China is no longer a sure thing, which is a break from what investors have come to expect over the last decade.

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This story begins in 2021, when ruptures in China’s property markets started to first appear. For years, analysts had been warning of a real estate bubble bursting in China, given the sizable government subsidies, leverage buildup, and low-interest rates characterizing the sector. At the center of the story was Chinese property developer Evergrande, which had racked up more than $300 billion in liabilities (2% of China’s GDP) by the end of 2021 and had some $37 billion in outstanding debt due within 2022. When Evergrande missed a $40+ million bond coupon payment and luxury developer Fantasia Holdings Group followed by missing a $206 million bond payment, the market started to price contagion. A sharp spike in U.S. dollar junk bond yields from Chinese companies ensued, and China’s equity market experienced a pronounced selloff.³

The next turn in the story was a predictable one, but also one the global equity markets did not seem to like. Earlier in the year, China hosted its twice-per-decade Communist Party congress, where it would decide whether to extend President Xi Jinping’s leadership. While President’s Xi grip on power seemed all but assured, markets were more concerned with China’s increasing hostility towards private business and specifically, technology companies. Chinese technology stocks were notably pummeled more than other categories of equities both in China and abroad.

By the middle of 2022, China was feeling all of these pressures but was also being hampered by an issue the rest of the world had largely moved on from: the Covid-19 pandemic. By mid-November, China had locked down the manufacturing hub of Guangzhou, which has 4 million residents and is known as an export powerhouse. Major companies also made it clear that China’s policies and slowing economic growth were having an impact – Apple Inc. warned investors that shipments of high-end iPhones would be lower than expected, and Foxconn Technology said plant disruptions and closed factories were hurting production.

More recently, Volkswagen and Honda have shut down production at a few key Chinese plants, as workers have not been able to show up and as authorities crack down. For Volkswagen, that has meant suspending production at its Chengdu plan and almost half of its production lines in Changchun, again due to worker shortages and also car-parts shortages. Honda shut down its Wuhan plant for two days, while Toyota also shifted production at key factories because of sporadic Covid restrictions.

All told, economic data from China continues to show signs of weakness. Earlier in November, factory gate prices – which represent the prices charged by Chinese companies – fell for the first time in two years. High inventories in the United States and other export partners combined with an anticipated decline in demand have led Chinese companies to pull back on pricing. According to China’s National Bureau of Statistics, Chinese producer prices fell by 1.3% year-over-year. China’s exports also fell in October which surprised economists, signaling that the softening across the global economy is hitting trade as well. Economists were expecting 4% export growth and instead got -0.3%.

For October, activity in China’s manufacturing sector measured by the purchasing managers’ index fell to 48 from 49.2, marking two consecutive months of contracting. Another index that measures activity in the services and construction sector in China fell month-over-month in November, to a very weak 46.7. All told, China’s economy grew by 3% in the first three quarters of 2022, a far cry from the 6+% growth the investment community has come to expect from the world’s second-largest economy.

Bottom Line for Investors

To make a challenging economic situation even more difficult, Chinese citizens across various cities have started protesting against Covid-19 restrictions, in a rare show of defiance against government policies. The Chinese government has shown some early signs of pulling back on the harshest restrictions, but it remains to be seen whether they will change course. The outlook is very unclear, and markets don’t like uncertainty.

The People’s Bank of China responded by cutting banks’ reserve requirement ratio by 25 basis points, which should free up about $70 billion in money available for loans to consumers and businesses.⁴ But this move is relatively small compared to the effects of slowing activity and sporadic factory closures, city-wide lockdowns, and now, protests. Given China’s status as the world’s second-largest economy, how all of these issues shake out will be key to the global economic growth narrative in 2023. Investors should be paying attention.

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¹ International Monetary Fund. 2022.

² Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

³ Wall Street Journal. October 4, 2021.

⁴ Wall Street Journal. 2022.

⁵ Zacks Investment Management may amend or rescind the Revolutionize Your Retirement guide offer for any reason and at Zacks Investment Management’s discretion.

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