(Yicai) May 13 -- Chinese enterprises faced a new macroeconomic landscape against severe external shocks and profound internal transitions in the first quarter of the year.

From an external perspective, the United States-Israel-Iran conflict has disrupted the fragile global supply chain, driving international oil prices to high levels, spreading imported inflationary pressures, and causing severe fluctuations in global capital and commodity markets.

From an internal perspective, China’s producer price index turned positive after 41 consecutive months of year-on-year decline since October 2022, while the consumer price index recorded a moderate increase. The Chinese mainland stock market rebounded, with the Nasdaq-like ChiNext Index reaching an 11-year high. The recovery in prices is reshaping corporate expectations.

The latest Business Sentiment Index from Cheung Kong Graduate School of Business shows that the overall industrial sector has stabilized and recovered in the first quarter, with extremely rare and drastic fluctuations in BSI history in terms of costs, prices, and actual investment behavior.

The surge in costs and the rise in prices have resonated, creating tensions between contractions on the production side and expansions on the investment side. The high external uncertainty brought about by the US-Israel-Iran conflict and the internal certainty of domestic price recovery have prompted enterprises to decisively vote for the future through capital expenditure.

There are certainly important positive signals on the price front, but transitioning from a single positive month to a comprehensive income recovery still requires joint verification from demand, sales volume, and cost absorption capacity.

The corporate environment has reported explosive breakthroughs in several sets of data this quarter.

The first is the ‘inflationary resonance’ between soaring costs and return of pricing power. The increase in energy bills buoyed by the US-Iran conflict is directly reflected in corporate costs.

The unit cost diffusion index soared from 62 to 72, and the raw material cost diffusion index jumped from 63 to 74. Under the strong impact of imported costs, the price diffusion index climbed from 47 to 56, surpassing the break-even point of 50 and setting a new high in recent years.

The second is the anticipated tension and micro-level confidence. In light of the US-Israel-Iran conflict, businesses are showing heightened awareness and vigilance. The proportion of companies expecting the real gross domestic product to rise in the next quarter has decreased, while that of firms believing that the China-US trade war will have negative effects in the next year or two has increased.

We believe this does not necessarily indicate a pessimistic outlook among enterprises, but rather highlights the highly unstable nature of expectations under the impact of extreme events.

In parallel, the diffusion index for expected business conditions rose from 48 to 51, returning to the expansion zone. While the macroeconomic environment remains challenging, conditions are showing signs of recovery. The positive turn in the PPI and the smooth increase in end-user prices have given entrepreneurs a tangible glimpse of improved cash flow and profit.

The pressure from the external environment has been transformed into the confidence to stick to the real industry.

Through tracking data over several consecutive quarters, we have observed that Chinese firms are undergoing a crucial psychological evolution, decoupling the uncontrollable macro environment from the controllable micro-level operations.

The production diffusion index fell to 45 from 53, and the finished goods inventory decreased to 47 from 50. Faced with short-term supply chain disruptions triggered by the US-Israel-Iran conflict and the extremely high spot raw material costs, companies are making tactical adjustments by slowing down current production to prioritize the consumption of previously acquired low-cost inventory.

Moreover, there has been a strategic surge in capital expenditure. The proportion of enterprises with fixed asset investments surged to 19 percent from 11 percent, and that of companies engaged in expansionary investments rose to 17 percent from 9 percent.

The US-Iran conflict has catalyzed the sense of crisis and ambition among businesses, with capital flowing into the market and being transformed into tangible fixed asset investment, largely directed towards hard technology, new quality productive forces, and efficiency tools that can withstand external shocks.

Whether this round of price recovery can truly translate into profit recovery depends on whether cost transmission is smooth, end-user demand can be sustained, and overseas orders remain stable. We predict that China’s economy will undergo three major qualitative changes this year.

The first is that the repair of balance sheets will continuously spill over into income statements, leading to a recovery driven by micro-level profitability that is both sustainable and internally motivated.

The second is that the value of new quality productive forces will gradually materialize, with high-tech manufacturing, artificial intelligence, commercial aerospace, and other cutting-edge sectors becoming the primary drivers of economic momentum.

The third is that dividends of companies’ globalization strategies will be widely realized on a large scale, as Chinese manufacturers will be deeply embedded in the global value chain with a more flexible and resilient stance, smoothing out the systemic risks brought by singular geopolitical events.

The authors of this article are Gan Jie, professor of finance and director of the Research Department on Finance and Economic Growth at CKGSB, Li Xuenan, professor of finance and director of the Research Department on Industrial Policy at CKGSB, and Wang Xiaolong, senior researcher at CKGSB.

Editor: Futura Costaglione