Are China’s Economic Support Measures Too Little Too Late For Oil Prices?

As the world's largest annual gross crude oil importer in the world since 2017, and before that as the key driver of the broader commodities supercycle, China's ongoing attempts to resuscitate its economic growth after three years of Covid remain a key factor to oil pricing from here. At the end of last week, with the spectre of a default imminent at China's largest property developer, Country Garden, Beijing rolled out a series of measures intended to stabilise the situation. The company has since secured a temporary reprieve from failure.  However, given that China's property market accounts for around a quarter of its gross domestic product (GDP) and about two-thirds of its household wealth, the potential for further crises in it to catalyse dramatic economic and financial fallout domestically and internationally - including in the global oil market - is enormous.  Before this latest crisis, the state of China's economic rebound after its turbulent Covid years had been unclear. On the one hand, there had been a series of poor data releases and news on 15 August that it is to stop publishing youth unemployment data. This followed the release of June's figure, which showed such unemployment at a record 21.3 percent. China's government is acutely aware of the potential for high youth unemployment to spiral into widespread protests. It also knows that just before the series of violent uprisings in 2010 that marked the onset of the Arab Spring, average youth unemployment across those countries was 23.4 percent. On the other hand, the end of July saw the release of second quarter (Q2) GDP, showing growth of 0.8 percent in the April to June period on a seasonally adjusted basis. This was higher than consensus analysts' expectations of a 0.5 percent increase. On a year-on-year basis, GDP expanded 6.3 percent in Q2: significantly better than the 4.5 percent rise in Q1. At around the same time as these figures were released, an official from China's National Development and Reform Commission (NDRC) pledged that the country would roll out policies to "restore and expand" consumption without delay. 

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This mixed messaging from the figures has compounded the dilemma facing the Chinese government in the best way to get the economy moving strongly again. Attempting to boost growth by spending more through a massive fiscal stimulus programme - as it did most notably in 2009 - would add to the country's already perilously high debt burden. For a long time, China's plan to tackle the rising debt burden was to pay for it through further growth. However, this 'Ponzi-like' model is clearly unsustainable. This said, cutting interest rates to spur further growth might well encourage further speculative practices on already heavily-indebted businesses. Consequently, China has been left to tinker around the edges, including a series of measures announced last week. These include cuts in lending rates, reductions in FX reserves required to be held by banks, and the potential relaxation of home-buying rules. In the past, this sort of manoeuvring has not been enough to tackle the structural malaise at the heart of China's massively overly-extended property sector, as seen in Country Garden, and before that in Evergrande as analysed by OilPrice.com back in December 2021. 

According to Rory Green, chief China economist for GlobalData.TSLombard, speaking exclusively to OilPrice.com last week, even back at the end of last year China's property sector was 30 percent larger than underlying demand, and he estimated a 1 percent hit to potential growth in a benign structural slowdown scenario. "We also noted that strong links to the banking system, local governments and households meant high risks of balance sheet recession and a more pronounced slowdown, and that danger has been increasing since April - discounting the 'zero Covid' period - with July TSF [Total Social Financing] data showing anaemic loan demand," he said. "The longer China takes to act, the more entrenched such conditions become and the larger the stimulus needed to alter the status quo, and we think it is a question of when, not if, stronger easing is enacted," he added. "Even [President] Xi Jinping's pain tolerance must have limits, especially if slower growth is seen to undermine national security," he told OilPrice.com last week. "All three of our stimulus signals - financial contagion, unemployment and growth target risk - are flashing amber at least, and meanwhile policymakers are showing a heavier hand in equity and FX market intervention and accelerating monetary easing, even though it is ineffective in current balance sheet recession conditions," he highlighted. "Even so, Beijing is likely to gauge the impact of fiscal measures before engaging in further large-scale stimulus efforts," he underlined.

This said, a key part of the reason for this general slowing down in China's rate of economic growth over the years, over and above the recent Covid-related downturn, is the shift in its core economic growth model. From 1992 to 1998, the country's annual economic growth rate was basically between 10 to 15 percent; from 1998 to 2004 between 8 to 10 percent; from 2004 to 2010 between 10 to 15 percent again; from 2010 to 2016 between 6 to 10 percent, and from 2016 to 2022 between 5 to 7 percent. For much of the period from 1992 to the middle 2010s, much of China's massive economic growth was founded on a huge energy-intensive expansion of its manufacturing capabilities. This also involved the mass migration of new workers from the countryside and into the cities, which required a huge energy-intensive infrastructure build-out. Even after some of China's growth began to switch into the less energy-intensive service sectors, the country's investment in energy-intensive infrastructure build-out remained very high. This pattern continued for many years, alongside the third phase of China's economic growth, which was the rise of a middle class that powered domestic consumption-led demand for goods and services. All these phases had the net result of increasing China's demand for oil and gas exponentially. 

Since the decline of Covid in China, this model has shifted again. The current phase of economic growth is reliant on just reopening the economy post-Covid and removing negative policies - property, consumer, and geopolitics - rather than on aggressive stimulus, to drive activity. "For the first time, a cyclical recovery in China is being led by household consumption, mainly services, as there is a great deal of pent-up demand and savings - about four percent of GDP - following three years of intermittent mobility restrictions," said GlobalData.TSLombard's Green. In terms of the effect that this will have on oil prices going forward, it is apposite to note that transportation, as a prime example, accounts for just 54 percent of China's oil consumption, compared to 72 percent in the U.S. and 68 percent in the European Union. In 2022, net oil and refined petroleum imports were eight percent lower by volume than the pre-Covid peak, with infrastructure and export-oriented manufacturing partly offsetting lower mobility and less property construction. "The certain outcome [of China's current phase of economic growth] is an increase in oil demand - we estimate a five to eight percent increase in net import volumes - but this is unlikely to cause oil prices to surge," Green highlighted. "This is especially true as China is buying at a discount from Russia," he concluded.

By Simon Watkins for Oilprice.com