Econosights: China – lockdowns, policy stimulus and regulatory burdens

Introduction
The Chinese economy is experiencing many cross currents. Current covid lockdowns (which started in March) are putting downward pressure on economic growth and policymakers are attempting to stimulate the economy to offset some of this weakness whilst also maintaining regulatory policies, especially in the real estate industry. China’s economic growth outcomes impact world GDP because of China’s importance to global growth (second largest economy in $US terms and largest in purchasing power parity terms) and also affect global inflation through the supply chain, as China is a major global manufacturing hub. We go through the outlook for China in this Econosights.

China’s economic growth target
Chinese GDP growth tends to be more predicatable compared to major developed economies because of the GDP growth target set by policymakers. The 5.5% growth target for 2022 is lower compared to the pre-covid levels of around 6-6.5%. However, actual 2022 growth is likely to be lower around 4.5%-5% because of the unexpected lockdowns (mainly in Shanghai and Beijing) as China continues to push for zero Covid community transmission. The good news is that the number of Covid cases has plummeted to ~3K cases/day currently from ~30K cases/day a month ago and a slow reopening is starting in Shanghai (officials previously set 1 June as a target date for reopening). But, the high transmissibility of Omicron means that more lockdowns later this year cannot be ruled out if the zero covid policy is maintained. China has vaccinated a large share of its population (at 86.6%) but the problem is that the most vulnerable age group (those aged over 80 years) are only around 50% fully vaccinated because of concern about vaccination. Concerns about the effectiveness of China’s vaccine Sinovac could be mitigated with the use of Pfizer or Moderna’s mRNA vaccine or if China will start manufacturing its own mRNA vaccine.

The latest economic activity indicators in China have been expectedly weak. Retail sales was down by 11.1% over the year to April and industrial production was 2.9% lower than a year ago. Fixed asset investment was better, up by 6.8% over the year to April. The May composite PMI rebounded to 48.4 from 42.7 in April which means that manufacturing and services activity is still contracting (any reading below 50 means a contraction in activity) but is improving from last month. GDP rose by a low 0.7% in the March quarter and is likely to fall in the June quarter. GDP growth in the second half of the year should have a large rebound (but its unlikely to be as strong compared to the 2020 rebound (because policy stimulus was more targeted towards direct household transfers then) if covid cases are kept down and from recent policy stimulus. We expect 2022 GDP growth to be around 4.5%-5%, i.e. below the growth target.

Policy stimulus in China
To offset some of the negative impacts to economic activity from lockdowns, policymakers have announced a range of stimulus measures including company tax rebates, more bond issuance for infrastructure projects, cuts to bank reserve ratios and the loan prime rate and an increase in liquidity. There is little direct handouts given to households. Fiscal stimulus done so far this year is worth ~7% of annual GDP which is below the 9-10% done in 2020 but more can be done from here.

The best way to gauge the pace of broad stimulus measures is to track changes in credit growth or “total social financing”. Credit growth has remained steady in recent months, running at just over 10% over the year to April while new bank loans are rising by close to 11% per annum (see the chart below), which are both below 2020/21 rates.

Given that policy stimulus has only recently been announced it may take some time for it to show up in the data.
Money supply growth has picked up, running at 10.5% over the year to April, reflecting higher liquidity in the system.

Impact of Chinese growth on the rest of the world

The biggest impact to the world from Chinese lockdowns has been the hit to the global supply of goods (as manufacturing facilities have had to deal with covid cases and closures) which was already been under pressure from the unexpected surge in consumer demand for goods over the last two years (from monetary and fiscal stimulus and as consumers brought forward spending on goods). Some of the indicators around supply chains look to be improving: semiconductor prices are moderating, commodity prices are high but the pace of increases is slowing, shipping costs are easing, the Baltic Dry Index is down form its highs and China is reopening its economy. Consumer demand for goods is expected to decline in 2022 as spending on services rises (from the global re-opening) and inflation from supply chain-related issues should ease, in line with recent falls in our pipeline inflation indicator (see chart below).

Changes in China’s producer prices can also be a leading indicator of global consumer prices, reflecting China’s importance in global manufacturing and trade. Producer prices were running at 8% over the year to April, well down from 13.5% pace in October 2021 – another sign of a slowing in global inflation.

Consumer inflation is lower in China compared to many other developed markets (2.1% over the year to April versus the US at 8.3% and Australia at 5.1% in March) because of less direct fiscal handouts to consumers and less monetary easing over 2020/21 which gives the People’s Bank of China more scope to ease monetary policy, if required.

The real estate sector, regulation and debt

The real estate industry has been negatively impacted since 2020 from tighter regulation (the “three red lines” policy which restricts the amount of new borrowing by property developers by capping their debt ratios), in an attempt by policymakers to deleverage the industry. As these regulations are still in place, housing activity remains slow (propery sales are low with property floor space sold down by 20.9% over the year to April and home price growth across the 70 major cities down by 0.1% over the year to April) although interest rate cuts will help. An overleveraged property market has also led to concern about high debt levels in China.

The concern around high levels of Chinese debt has been around for years because of the fast growth in non-financial debt (concentrated in the corporate sector), which has increased to 290% of GDP in 2020, from 181% in 2010. The build-up in debt across advanced economies has occurred at a slower pace (see the chart below) although the pandemic led to a big lift in debt across the advanced world which will take a while to reduce.

Policymakers have been attempting to regulate the banking system to reduce “shadow” lending to address the issue of high corporate debt and lower economic growth should help reduce debt levels.

Some upside risks

The trade relationship between China and Australia could improve with the fresh Labor government which could see a reversal of some tariffs and trade restrictions. There could potentially be some roll-back of tariffs from the US before the mid-term elections and as inflation remains a key issue for hosueholds.

Conclusion

Chinese shares have been hit hard in recent years, and are down by 30% since a peak in early 2021. After falling by 17% since early this year, with a price-to-earnings ratio around 5, Chinese shares are trending sideways (similar to the trends across global shares) and look relatively cheap from a valuation perspective. Along with the better growth outlook for China in the second half of the year, Chinese equities could offer value from a long-term perspective, if investors can withstand short-term volatility.