China faces a ‘confidence trap’ as economic recovery falters

(Bloomberg) – The Chinese economy is at risk of falling into a confidence trap as the post-Covid recovery loses momentum, leaving Beijing with a problem that cannot be easily solved with traditional tools like interest rate cuts and infrastructure stimulus.

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Evidence of low business and consumer confidence was everywhere in this week’s official data, which showed that economic activity lost momentum in April. Private companies barely increased investment, while households cut back on commodities such as household appliances.

This raises the prospect of a vicious circle as businesses and households hold back on spending, slowing the pace of the recovery, which in turn further erodes confidence, said Michael Hirson, a Chinese economist at 22V Research LLC and a former US Treasury attache in Beijing. Citigroup Inc economists described China as “on the brink of a confidence trap”.

This week’s poor economic data and concerns about the outlook took a toll on the Chinese currency, which weakened above a key $7 mark on Wednesday. The country’s benchmark stock indices lag behind their major Asian counterparts in the quarter as well, while government bonds rallied on expectations of further easing of central bank policy.

Two independent surveys show that while private sector confidence has improved since the prolonged coronavirus lockdowns last year, it has yet to regain its pre-pandemic momentum. The Cheung Kong Graduate School of Business survey, which includes relatively successful private companies, outperforms Standard Chartered Plc’s SME Index.

A high-frequency study of Chinese consumer sentiment by Morning Consult shows that while confidence surged at the start of the year, it peaked earlier than in previous recoveries and “now appears to be waning,” said Jesse Wheeler, an economist at the U.S. consulting firm.

Citi economists blamed low confidence on the scars of China’s strict pandemic regulations and the chaotic end of Covid Zero policy late last year. Another reason has been the “political excesses” of the past few years, as Beijing has hit sectors like real estate, technology and education with rapid regulatory changes.

China’s leadership is aware of the problem, with the ruling party’s Politburo last month identifying low confidence levels as a challenge to the economy. Top officials have stepped up their rhetorical support for private companies, especially the tech sector, and promised to boost household income growth.

Confidence Policy

However, specific policy initiatives to boost confidence have been on a small scale. China’s internet regulator launched a campaign last month to counter criticism of the private sector and online entrepreneurs as a way to improve the business environment. Local governments promote private companies, such as a partnership between the city of Hangzhou and Alibaba Group Holding Ltd., which is based there.

Companies seem to want more. “Entrepreneurs seem to be shifting the burden of proof to the new prime minister, Li Qiang, to show that the environment is really improving,” Hirson said.

Li visited a number of manufacturing companies on a trip to eastern Shandong province this week, reiterating that the key to ensuring a sustainable economic recovery is “strengthening confidence in development,” the official Xinhua news agency reported. He said China would take more action to attract foreign investment and stabilize its international market share.

“We need to do more certain things to balance the impact of various uncertainties,” he said at a meeting with local officials and business representatives. “We must do our best to strive for the best possible results.”

Foreign companies also face additional obstacles. A recent US Chamber of Commerce survey shows growing pessimism about the US-China relationship as political tensions and competition in the tech sector escalate. High-profile investigations against foreign companies such as Bain & Co. and Mintz Group, have also raised concerns.

Traditional government policies to stimulate the economy – state-led infrastructure investments and bank loans – will be less effective when confidence is weak.

“Unlike previous cycles, we don’t see an easy fix this time around,” Nomura Holdings Inc economists wrote in a note. led by Lu Ting. “The real obstacle to sustaining growth recovery is a lack of self-confidence.”

Certainly, for some economists, the issue of trust is mainly a matter of time. The strong recovery in service spending should translate into jobs, boosting incomes, said Adam Wolfe, a Chinese economist at Absolute Strategy Research.

“I think consumer confidence will gradually improve,” he said.

The private investment figures may also be less worrying than they appear, as they are overwhelmingly driven by a decline in the real estate sector, which is generally dominated by private firms. Investment growth in the manufacturing sector, which is also dominated by the private sector, has held up better.

Beijing’s reluctance to provide direct income support to households will make it difficult to “rebuild confidence,” said Houze Song, an economist at US think tank MacroPolo. A more viable option, he said, would be to cut employer-required contributions to workers’ National Insurance accounts, which could encourage hiring.

–With help from Jill Disis and Fran Wang.

(Updates with Chinese Prime Minister’s comments)

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