Barclays Warns of Japan-Style Recession Risk for China

China’s economy is currently facing a significant downturn, marked by a decline in investment, production, and consumption. This situation is exacerbated by a worsening labor market and falling property values.

Analysts from Barclays have raised alarms about the potential for a Japan-style balance-sheet recession, highlighting that these factors could pose serious risks to China’s GDP forecasts. Although there are expectations for a growth rate of 4.8%, the outlook appears grim unless more aggressive and coordinated policy interventions are made to address these issues.

### Economic Slowdown and Key Factors

The Chinese economy is grappling with a series of interconnected challenges that are intensifying the slowdown. Data for July 2024 indicates a weak beginning to the third quarter, with industrial production growth slowing, property investment continuing to decline, and retail sales remaining low.

Despite a low base from the previous year, retail sales growth was below 3% for the second consecutive month. Additionally, the industrial production growth rate decreased to 5.1% year-on-year in July, falling short of expectations.

On the investment front, Fixed Asset Investment (FAI) growth has hit a nine-month low of 2% year-on-year in July. This decline is largely attributed to a downturn in property investment and a weakening in manufacturing investment, although a slight rebound in infrastructure investments has provided some offset.

Moreover, July’s data highlighted a sustained drop in private credit demand and a negative GDP deflator for the fifth straight quarter, signifying ongoing deflationary pressures within the economy.

### Real Estate Sector in Crisis

The real estate sector, a vital component of China’s economy, remains entrenched in a prolonged contraction. Despite efforts to stabilize the market with new measures introduced in May 2024, housing activity has continued to decline.

Property investment plunged by 10.8% year-on-year in July, and new property sales fell by 15.4% year-on-year, exacerbating the contraction seen in previous months. Additionally, the real estate market in 30 major cities showed further declines in August, indicating that the housing market correction is far from finished.

### Labor Market and Consumption Weakness

The labor market in China is also showing troubling signs, with urban unemployment rising to 5.2% in July. This deteriorating employment situation is dampening consumer confidence, which is reflected in weak retail sales growth.

Despite government initiatives to boost auto sales, the sector has seen declines for five consecutive months. The ongoing downturn in the housing market has also impacted property-related retail sales, further straining overall consumption.

### The Vicious Cycle of Deflation and Wage Declines

Barclays analysts are concerned about a troubling cycle involving wages and prices. Declining wage growth and increasing unemployment are occurring alongside falling price indicators, as evidenced by the negative GDP deflator persisting for five consecutive quarters. This situation is stoking a deflationary trend that leads to further stagnation in wages and job losses, creating a challenging cycle that is hard to escape.

### Structural Challenges and Long-Term Outlook

The current economic difficulties are not just cyclical; they expose deeper structural problems within China’s economy. The collapse of the housing bubble has significantly damaged household balance sheets, initiating a deleveraging process that could take a decade or more to resolve.

Even with historically low-interest rates, demand for borrowing—whether for consumption or property purchases—remains insufficient. This deleveraging process mirrors past experiences in Japan and the United States during their financial crises, suggesting that China might face a prolonged period of economic stagnation.

In addition, private businesses are becoming increasingly wary of taking on loans and expanding capital expenditures, despite regulatory efforts to enhance credit growth. This hesitancy reflects a broader lack of confidence in the economic outlook, further deepening the slowdown.