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Inside China 26 January 2021

Prognosis far from assured

Jeremy Stevens

China’s economic resilience has been impressive, and recovery has been reasonably robust — but the prognosis is far from bullet-proof. The outlook relies on policymakers’ ability to navigate the path balance between incompatible near- and medium-term policy priorities. In turn, much hinges on consumption’s uninterrupted return to at least 2019 levels, and maintaining the run rate of manufacturing investment growth, which has been lively since July. Either way, those record-breaking Q1:21 data outcomes will demand careful scrutiny – especially because China’s “new normal” of GDP growth under 5% will return rather swiftly.

Based on high-frequency monthly macroeconomic data points, our economic activity gauge bottomed in February and then improved sharply, from -7.74% in February to +5.66% in October. Since, it has since been trending sideways, rising to 5.91% in November and then easing to 5.81% in December. Policymakers in Beijing should be satisfied but they will remain wary that activity remains precariously poised.  

Critically, the recovery has broadened gradually: originally the recovery was driven by traditional levers – most notably, of course, infrastructure and real estate investment. However, even though both hit record absolute levels for each of the past three quarters, the growth rate for infrastructure and real estate peaked in July and October respectively. Policymakers, loath to go down this path, had already started to ease on these short-term economic drivers in the latter part of last year – both growth rates benefiting from relatively low levels recorded in December 2019.

This year, policymakers plan to pivot away from stop-gap measures tooled to place a floor under economic activity and will feel able to do so now that a wider arc of economic data points is firmer. Pivoting back to deleveraging and de-risking is necessary. This implies that just as swiftly as the recovery took hold, it will fade — and the “new normal” of slower growth will return because headwinds are building, not least of which is placing the de-risking campaign front and center once again, which cascades into more neutral fiscal and monetary policy, but translates into headwinds for government incentivized infrastructure spending, and tighter scrutiny over the real estate sector. Additional complexity stems from the coming due of an extraordinary amount of loans to SMEs extended last year, and the general erosion to the resilience of the financial system, which will also inevitably divert resources.

Importantly, manufacturing investment growth has accelerated since turning positive in July. The strength of external demand has pushed capacity utilization rates in various industries towards their limits, exemplified by buoyant PMI for manufacturing – especially the Caixin index which is weighted more towards smaller, private-owned and export-orientated industry. Note that both the official and Caixin readings apparently topped out in November, and much will depend on the timing of the degree to which advanced economies can restore full operations. Nevertheless, we foresee immediate tailwinds for the sector, which has manifest in proxy data for corporate investment intentions picking up in the Mainland in recent months. Furthermore, government policy can incentivize investments in the sector targeting the meeting of domestic demand or moving up the value chain, both of which are consistent with China’s longer-term objectives, including specifically dual circulation.

This matters a great deal as manufacturing remains the biggest sub-component of investment, and positive momentum there could offset anticipated sluggishness elsewhere. In 2021, at the very least, infrastructure spending growth looks set to slow as policymakers shift from a proactive fiscal stance to a more neutral one, and towards reining in leverage. This presumably explains Beijing’s lack of urgency in allocating local special bond quotas this year. By October of 2019 – long before the pandemic shut down this economy – Beijing had announced the 2020 quota, allowing localities space to issue bonds and keep the run rate of infrastructure projects stable. Meanwhile, tougher restrictions on real estate developers borrowing introduced last August, have already weighed on property starts. In fact, we foresee both real estate and infrastructure investment potentially contracting this year — but only after record-breaking data prints into May. That said, each component of investment will get off to a spectacular start in Q1:21. However, we anticipate a growth rate lower than market consensus as Beijing will prefer to smooth what it can control over a longer period of time because stronger gains made in the early part of 2021 will make it more difficult to maintain positive year-on-year growth in latter quarters — against which policymakers will clearly guard.

Most important to the 2021 trajectory will be household spending. Consumption has thus far lagged the recovery in income growth. It is therefore promising that, even though retail sales ended the year -3.9% y/y in 2020, the monthly data remains robust: +4.056trn in December, up 4.6% y/y, from +3.6% y/y in November. The labour market, less negatively affected, is seeing consumer confidence clawing back from Q1 – the PBOC’s diffusion index of current and future income are both approximately halfway back to pre-Covid levels and above 50 points. If the status quo holds, households should soon start spending more freely. Indeed, savings rates increased in 2020, implying that households are on average in a stronger financial position than pre-Covid — but also more cautious. Already, at the higher-end, Chinese tourists have increasingly been supporting local options, and at the lower-end, even though policymakers are starting to withdraw investment-focused stimulus, they will maintain or expand measures to support consumption.

Tied together, it seems reasonable to assume that most macroeconomic data through much of Q1:21 will be reporting record highs. Indeed, the Chinese economy seems set to rally, first from 6.5% y/y in Q4:20, then to a staggering 15.0% in Q1:21 — before slowing to 7% y/y in Q2:21, and to below 5% in H2:21. This implies 8.3% growth in 2021 but also that this period of rising GDP growth is likely to be short-lived.

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