In recent months, the economic landscape of China has become increasingly complex, characterized by a decline in export growth and persistent deflation, as evidenced by negative figures in the Producer Price Index (PPI). These indicators underline a dual predicament: external demand contractions coupled with lackluster domestic consumptionAs the year 2023 unfolds, the diminishing support of exports to economic growth is becoming evident, prompting a critical need to stimulate domestic demand.

In the post-pandemic era, exports, which had been a significant contributor to the economy, have seen a notable declineAccording to the data released by the General Administration of Customs, China's exports measured in U.Sdollars fell by 8.7% year-on-year in November, marking two consecutive months of negative growth

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This reduction represents a significant drop of 8.4 percentage points compared to the previous month and a staggering decline of 26.7 percentage points from the high of July.

The reasons behind this rapid decline in export growth are multifacetedOn one hand, the supply chain disruptions caused by the pandemic have affected the production capabilities of exporting firmsOn the other hand, the aggressive interest rate hikes by Western countries have begun to slow down the global economy, increasing the pressures on external demandThe decline in commodity prices has also contributed to the reductions in export values.

Among these factors, the supply shocks caused by the pandemic are expected to be temporaryWith the swift resumption of work and production, it is anticipated that gaps in the supply chain will be quickly rectified in the coming months, leading to a likely rebound in export growth

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However, the decline in external demand poses a more sustained threat; if the economies of Europe and the United States enter a recession in 2023, Chinese exports could face even greater pressures.

On a different front, the economic indicators released by the National Bureau of Statistics show that in November, the Consumer Price Index (CPI) rose by only 1.6% year-on-year, a decrease of 0.4 percentage points from the previous month and down 1.2 percentage points from the high in SeptemberIn contrast, the PPI fell by 1.3% year-on-year, also marking two consecutive months of negative growth, and dropping from a high of 13.5% in October 2021.

Historically, the CPI has been more influenced by prices of food commodities like pork, whereas the PPI has been more responsive to demand fluctuations

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The significant and continued decline in PPI indicates substantial economic pressures and raises concerns about the potential risk of deflation.

Both the decline in exports and the ongoing decrease in PPI signify an urgent necessity to bolster domestic demand to stabilize the economyPolicymakers have begun to respond to this situationA meeting held on December 6 focused on analyzing the economic tasks for 2023, placing a greater emphasis on maintaining growthIt highlighted the necessity of "doing a good job in stabilizing growth, employment, and prices,” calling for efforts to expand domestic demand and fully leverage the foundational role of consumer spending along with essential investments.

While the current economic reality appears weak, the market is beginning to warm up amid strong policy expectations

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The Shanghai Composite Index has successfully risen above the 3200 mark, with cyclical sectors such as finance, real estate, and consumer goods showing signs of recoveryAdditionally, the yuan has strengthened to below 7 against the US dollar, signaling an upcoming bullish trend as we approach the new yearThe upcoming Central Economic Work Conference is anticipated to signal further stability measures, setting the tone for economic recovery as a central theme in 2023.

The dissection of the causes behind declining exports reveals a complex interplay of factorsWhile the market had anticipated a downturn in exports, the rapid nature of the decline in recent months caught many off guardThe pandemic disruptions are likely the primary short-term factors influencing this trend.

According to GF Securities, the export drop in November reflects both the pandemic’s ongoing effects and the rising regional controls

Various segments of foreign trade—raw material supply, factory production, and logistics—face potential disturbances.

The electronics sector, including mobile phones and laptops—major contributors to exports—saw supply chains affected by the pandemic, leading to a remarkable 23.7% year-on-year drop in high-tech product exports, while machinery and electronic products fell by 11.1% year-on-year.

However, it is critical to remember that pandemic impacts are expected to be short-livedAccording to Shenwan Hongyuan Securities, as measures to optimize pandemic response are implemented swiftly nationwide, supply chain disruptions will ultimately be viewed as temporaryHistorical data suggests that once pandemic scenarios improve, export recovery occurs at a rapid paceFor example, in May, exports rebound to pre-pandemic levels within just a month.

Nevertheless, external demand's decline represents a more persistent threat

The increasing likelihood of recession in Europe and the U.S., along with the subsequent effects this may have on Chinese exports, looms largePredictions estimate a further decline in China’s export growth rate in 2023, potentially dipping to -2.5% as global demand falters.

The persistent decrease in PPI warrants particular cautionThe Chief Statistician at the National Bureau of Statistics, Dong Lijuan, indicated that CPI figures have been affected by pandemic conditions, seasonal factors, and high bases from the previous yearThe CPI posted a year-on-year increase of merely 1.6%, with food prices rising at a slower pace.

There are concerns surrounding PPI’s continued drop, which has stemmed from high bases as well as external demand slipping, affecting prices of major commodities

In December, global recession factors manifested clearly, evidenced by significant oil price declines, with crude futures reaching $71.6 per barrel, approximately 45% lower than their mid-year peak.

Nevertheless, over longer time frames, CPI inflation patterns mainly reflect changes due to significant market factors, primarily underpinning variables such as the pork cycle, but they show a laggard response to economic demand variationsIn contrast, the PPI remains more sensitive to such changes and bears greater weight in investment circles.

In summary, the sustained decline in PPI underscores a marked stagnation in global demand alongside domestic consumption weakness, highlighting a profound economic riftIn response, the Chinese government is actively preparing for a growth rebound through a series of strategic meetings and policy implementations.

The meeting held on December 6, which examined the 2023 economic agenda, reiterated the commitment to enhance market confidence by integrating strategies for expanding domestic demand with improvements to the supply side

There is a focus on ensuring the stability of growth, employment, and prices, thereby effectively mitigating major risks and fostering a better economic environment for quality and reasonable growth.

As is customary every December, the Central Economic Work Conference outlines the economic direction and goals for the upcoming year—an event that generates significant attention from the marketOn the fiscal policy front, the meeting stressed the need for an “aggressive fiscal policy to enhance effectiveness.” Proposed enhancements include potential increases in the fiscal deficit rate and, as necessary, issuing special treasury bonds aimed at stabilizing growth and safeguarding livelihoods.

Given the current state of government debt and macro leverage in China, particularly the relative stability of the central government’s leverage ratio, there is a conducive environment for implementing robust fiscal measures.

On December 9, the ministry decided to issue a special treasury bond valued at 750 billion yuan, a unique financial move targeting specific economic conditions

These special bonds will not count towards the regular fiscal deficit, enabling tailored responses to pressing economic needs.

Experts project that in 2023, the fiscal deficit rate may rise to between 3% and 3.2%, with high levels of issuance for special bondsCalculations indicate that combining 4 trillion yuan in special bonds with 1 trillion yuan in special treasury bonds could drive government-related investment growth to over 8% for the year.

Regarding monetary policy, the emphasis was placed on a “precise and powerful” approachAnalysts predict the use of structural tools to complement fiscal strategies, thus enhancing their capacity to stabilize the economyWe can expect a continuation of instruments like special re-loans and PSL, aimed at further bolstering economic stability.

It is crucial to note that the meeting did not elaborate on housing policies, a topic of substantial interest