China's economy under 'significant amount of stress': Analyst

China's economic situation takes a turn after the country's central bank slashes its lending rates and its real estate sector comes under pressure. Rhodium Group Associate Director Charlie Vest joins Yahoo Finance Live to explain China's economic outlook amid its ongoing growth slowdown.

"The challenge that China is facing now is that the room to continue this sort of debt-driven growth model is much weaker than in the past," Vest says. "Banks have a large share of unrecognized bad debt on their books that can strain their profitability in ways that the data doesn't necessarily show."

Vest also lays out the impact of China's refusal to publish youth unemployment figures going forward and the economic ripple effects on foreign markets.

Video Transcript

SEANA SMITH: At central bank, a cutting policy rates for the second time in three months in an effort to boost its struggling economy. Reports out on retail sales and factory output also missing expectations. And the country saying that it will no longer report youth unemployment after months of increases.

For more on that, we want to bring in Charlie Vest, associate director of the Rhodium Group. Charlie, it's great to see you here. So China ramping up its easing efforts. We have some more concerning economic data coming out today. How much trouble is China's economy in?

CHARLIE VEST: Thanks for having me. Yeah, the Chinese economy is definitely under a significant amount of stress right now. The key thing to watch here is the real estate sector.

This has been now the 28th month of declines in new construction activity in the real estate sector that puts China's overall construction activity down by over half since it reached its peak in middle of 2021. And that has a big impact across the economy, not least on local governments who have relied on land sales to balance their books for years and are now under a considerable amount of stress.

AKIKO FUJITA: Yeah. I mean, when you look at the real estate sector, the numbers that we got from Country Garden sort of reigniting those concerns again this week, in the past when we have seen a slowdown in China, we have seen the stimulus come through, not just through rate cuts but also incredible spending in the real estate sector, racking up debt. How does this time look different?

CHARLIE VEST: The challenge that China is facing now is that the room to continue this debt-driven growth model is much weaker than in the past. Banks have a large share of unrecognized bad debt on their books, and that's constrained their profitability in ways that the data doesn't necessarily show.

And so banks aren't able to continue to push a lot of money out into the system. And that's really what the core of the issue is right now. What we are looking for is potential signs of consumer side stimulus to help with the malaise in retail spending, as well as a looming restructuring of local government debt.

SEANA SMITH: Charlie, is the worst yet to come?

CHARLIE VEST: I'd say we're nearing the bottom. Our estimate-- around mid-2021 when the real estate market hit its peak, there was around 1.5 billion square meters annualized of residential real estate construction activity. And our view at that time was that a sustainable level of construction in the real estate sector was around 550 to 750 million square meters a year.

And that's just based off of demographics and family formation. We're reaching the point now where-- last month it was around 750 million square annualized. We're reaching the point where the real estate market might start to bottom out and start to see a flattening of that.

The issue is, though, that China's economy really did rely on real estate growth for many years to drive growth. And even when it does bottom out, it's going to be at a much lower level activity in the past. We're not going back to the real estate go-go years of 5 or 10 years ago.

AKIKO FUJITA: So what does that mean overall in terms of the growth picture? I mean, we were looking at 5% this year. Does it look like they'll hit that target? Are we talking just below that?

CHARLIE VEST: I think we're probably looking at below that. If you break down growth into its constituent factors, thinking about consumption from households, consumption from government, investment, and net exports, really, the only thing that's going to be driving growth in 2023 is the modest recovery from the consumer side. So yeah, we're expecting much lower growth in around 5% target that the government set earlier this year.

AKIKO FUJITA: Charlie, it's never a good sign when you've got a government that says we're not necessarily going to report this data right now because of methodology. That's what happened today when we got that announcement on youth unemployment. We know it's been upwards of 20% for some time. What does that tell you about how the government's looking at that number, and how significant that is?

CHARLIE VEST: Yeah, so the last number we had from I guess it was June was 21.3% unemployment for folks aged between 16 and 24. And in this last data release, they didn't include that number. It's gotten a lot of negative press attention or just press attention in general as a signal of the performance of the economy.

So in a way, it's not surprising that the Chinese government decided not to report that number, especially because in July and August, we're likely to see a spike in that number from recent graduates who are now on the job market and still haven't found a job yet. I think the more concerning thing is if this fits in a pattern of discontinued data series and general data transparency issues that make it hard for folks like us to really present a clear picture about what's going on in the Chinese economy more generally.

SEANA SMITH: Charlie, this move right there, restricting access here to another key data point, how unnerving is this when we're trying to best gauge what the situation is in the world's second largest economy?

CHARLIE VEST: It certainly makes it more challenging. There are ways that you can track the performance of the Chinese economy with more reliable figures. But those very numbers are leading us to be very concerned about the state of the economy.

One of the best metrics to understand how fast China's economy is growing in real terms is the credit growth. So total social financing is a measure of how much credit is flowing in the Chinese economy. That growth rate hit 8.9% last month, which is the lowest on record.

AKIKO FUJITA: So connect the dots for us. I mean, we're talking about the world's second largest economy. We saw oil, for example, down today on concerns about the demand coming out of China. I mean, when you look at the economic picture and the slowdown that is happening in China, what are the ripple effects you're looking at?

CHARLIE VEST: Sure. So yeah, the renminbi is under a considerable amount of pressure, both from these negative sort of bad reporting and from general capital outflows that have been happening throughout these past few months as China has reduced rates and there's been weaker foreign investment into the economy. And that's putting pressure on the renminbi.

The PBOC has sought to defend the renminbi at around 7.3, which is a natural place for it to defend since that's about the lowest that it got over the past decade going back to like 2007, and I expect will continue to defend at that level. But persistent weak renminbi is going to affect the price of China's exports. It's going to affect China's imports. And it's going to affect the commodity markets that so many developing countries that export commodities to China-- that's going to affect their bottom line.

SEANA SMITH: Certainly global implications that will continue to follow here. Charlie Vest, associate director of the Rhodium Group. Thank you so much.

CHARLIE VEST: Thanks for having me.