China's Economic Struggles Intensify Amid U.S. Tech Investment Clampdown

China's Deflation Worsens

Aug 16, 2023

Before Article Market Predictions:

The United States has recently enacted an executive order aimed at curbing American investment in Chinese companies with military affiliations. This action is part of a broader initiative to address national security concerns while maintaining a cooperative relationship with China.

The executive order specifically targets industries such as advanced computer chips, microelectronics, quantum information technologies, and artificial intelligence. The objective is to limit U.S. investment in sectors that could potentially enhance the military capabilities of China's ruling Communist Party. This aligns with existing restrictions that prevent Chinese access to U.S. processor chips used in smartphones, artificial intelligence, and other technologies on security grounds. Several Chinese companies associated with military modernization are already excluded from American financial markets.

The Chinese government has criticized these restrictions, accusing the U.S. of attempting to hinder China's development and maintain its own technological supremacy. The Chinese Foreign Ministry has called for an immediate reversal of the decision, warning that it could disrupt global supply chains.

The conflict between the United States and China has sparked fears of decoupling which refers to a potential division into separate industrial markets with conflicting standards - a situation where products and components from one market cannot be used in another potentially hindering innovation and economic growth.

China's Economy Faces Deflation Amidst Deepening Debt Crisis

Meanwhile, China's economy is facing significant challenges. In July 2021 new bank loans in China plummeted to their lowest level since 2009 at 345.9 billion yuan ($47.80 billion). This figure represents a substantial drop of 89% from June 2021 and falls significantly short of analysts' expectations. Household loans primarily mortgages contracted by 200.7 billion yuan in July following a significant increase of 963.9 billion yuan in June due to a deepening debt crisis in the property sector. Furthermore these economic troubles are impacting its currency too; offshore yuan depreciated against U.S dollar nearing its weakest level this year.

Weak demand both domestically and internationally has hampered China's economic momentum in recent months despite robust bank lending in the first half of the year. Despite the lifting of Covid-19 restrictions, China is experiencing falling prices across a range of goods, including commodities, daily essentials, and consumer products. This situation sharply contrasts with the United States and other developed Western economies where inflation has been on the rise following the easing of Covid restrictions.

In response to these economic challenges, China's central bank reduced its benchmark lending rates by 10 basis points in June, the first reduction in ten months, but analysts predict that further small cuts may not be sufficient to rejuvenate the economy if consumers and companies are reluctant to borrow.

Chinese policymakers are not overly concerned about falling prices and dismiss suggestions that deflation will persist. The central bank has reduced interest rates multiple times this year but larger-scale stimulus measures have not been implemented due to constraints such as high debt levels.

China's Real Estate Sector in Turmoil

The real estate sector in China is currently grappling with significant challenges as exemplified by the situation at Country Garden Holdings Co., Ltd., a leading property developer whose stock plummeted by 18% following an announcement that trading would be suspended for at least ten onshore bonds due to potential losses amounting to RMB55 billion ($7.62 billion) for H1 2023.

Analysts from Morgan Stanley have downgraded shares in Country Garden and slashed their share price target by 69%. They predict that negative news flow could exacerbate sales decline at the company while heightening home buyers' concerns about halted construction projects.

The company has failed to make payments on nearly a dozen onshore bonds, prompting discussions about debt negotiations and potential restructuring. Foreign investors holding approximately $10 billion in Country Garden's bonds are expressing concern over the potential impact of this default on their investments.

Country Garden's difficulties primarily stem from its substantial exposure to smaller cities struggling with housing oversupply and population outflows. Moreover, the Chinese government's policy shift favoring larger, more resilient cities does not bode well for Country Garden. Consequently, sales recovery is expected to be a slow process. The company requires monthly sales of approximately 28 billion yuan to 30 billion yuan to generate sufficient cash flow and complete pre-sold projects.

The precarious state of both Country Garden and China’s broader real estate sector has heightened concerns about heavily indebted property markets which are grappling with slumping sales difficulties securing financing and unfinished projects all contributing factors that underscore these challenges faced by property developers.

One primary challenge facing China's property market is high levels of debt incurred by numerous Chinese real estate companies who relied heavily on borrowing resulting liabilities far outweighing assets raising concerns about potential market crash impacting economy Another issue is 'ghost cities' constructed anticipating population growth but remain largely uninhabited leading excess supply properties causing prices nosedive leaving developers unsold inventory.

Growing Crisis in China's Shadow Banking

In addition to the real estate sector, China's shadow banking sector is also under close examination. Three companies have reported non-receipt of payments from investment products managed by Zhongrong International Trust. The missed payments are likely to exacerbate concerns about China's $2.9 trillion trust industry, which amalgamates features of commercial and investment banking, private equity, and wealth management. Defaults on trust investment products, particularly those linked to real estate, have surged in recent years. This has led many financing trusts to decrease their exposure to the property market.

Adding to these concerns, Chinese banks extended the smallest amount of net new loans since 2009 in July. Despite regulatory crackdowns on shadow banking diminishing some of its previous influence, China's trust sector remains critical to monitor as it provides capital to marginal borrowers and is closely connected to key sectors such as housing and infrastructure.

Wrap Up

The escalating tensions between the U.S. and China over new restrictions on tech investments, coupled with China's deepening economic challenges, are creating a complex and uncertain global economic landscape. Meanwhile, China's economy is grappling with a deflationary trend, a deepening debt crisis, and a struggling real estate sector, all of which are causing significant concern for investors and policymakers. The crisis in China's shadow banking sector further exacerbates these issues, with missed payments and defaults on trust investment products increasing. The global economic interdependence cannot simply overlook the economic deflation happening in China and the escalating US-China tensions.

After Article Market Predictions:

For more analysis on these topics, check out these articles:

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