Since the pandemic, Chinese economy has never fuller recovered. It has been faced with consistent deflation and low growth phase. The collapse of the property sector, which once accounted for 25% of GDP and 38% of national fiscal revenue, was undoubtedly the main culprit. Beijing had planned to divert financial resources away from the housing sector to high-tech industries and it did achieve a lot in the green sector, but the resulting substantial over-capacity worsened deflation, which was initially driven by the housing slump. Since mid 2024, Beijing launched a nationwide “anti-involution” campaign to prevent enterprises from adopting “cutthroat” prices and rein in production. But it has not worked even after almost 1 year. We believe the anti involution campaign might in fact lead to cuts in investment & output leading to further demand erosion. The anti-involution campaign by nature favors state-owned enterprises at the cost of smaller private ones, depressing otherwise good investment and economic activity. In recent July activity trackers, almost all except services missed market estimates. Leading the slowdown was a sharp drop in fixed asset investment which declined by est. -5.2% YoY across the board, including a notable drop in manufacturing investment. Industrial production growth also slowed by 1.1ppt to 5.7%. Property sales, prices and investment have also declined further. On the consumer side, retail sales growth slowed by 0.9ppt to 3.7% YoY due to the impact of a temporary suspension of consumer trade-in subsidies (which resumed in late-July). The property market has further weakened. On a seasonally adjusted basis, housing sales, property investment and housing new starts further contracted. Furthermore, the decline in housing prices persisted. Monthly new yuan loans posted a net decline of 49.9 billion yuan in July, compared with a 2.2 trillion yuan increase in June. That is the first negative reading since July 2005. Both household & corporate funding dropped in July. We estimate 2025 real GDP growth forecast at 4.8% but it could be lower if there are no fiscal stimulus programs/monetary easing measures launched soon. China’s credit growth has been stuck in a low gear since 2022. Not even interest-rate cuts by the central bank were able to reverse the slowdown in lending. As deflation in the economy becomes increasingly pervasive, it’s souring household and business expectations for future income and profit. The danger is that without a timely fix to reflate the economy, China may follow the footsteps of Japan and become trapped in decades of deflation and low growth. We see significant similarities of today’s China to 1990’s Japan’s balance sheet recession. High levels of debt, low interest rates, a collapsing real estate market and slowing output (courtesy the current anti-involution drive) are hallmarks of balance sheet recessions which tend to stay for decades once in place. If there are no policy support measures announced soon, we expect China to see sustained deflation as well as low growth. This implies lower commodity prices and a deflationary impulse to global economy especially to targets of Chinese dumping such as Asian economies & Eurozone. China (the world’s largest exporter) has diverted trade to other large consumer markets as the US (the world’s largest importer) has sharply raised tariff rates YTD. China’s ongoing domestic deflation has also supported this trade diversion trend. The risk is that the US trade war – which already largely centres on China – morphs into a broader anti-China trade war as a result of this trade diversion. This will further add to local deflation and balance sheet issues. Hence July’s weak data should sound an alarm to China’s policy makers.
