THE TRADE REPORT for April brings further evidence of the headwinds facing the economy.
China’s General Administration of Customs reported today that goods exports grew by 3.9% year-on-year in April in dollar terms, the slowest pace since June 2020, while imports showed no growth year-on-year.
Since importers are paying significantly higher prices for commodities, this implies substantially lower import volumes than last year.
Lockdowns in big cities have severely disrupted global supply chains. At the same time, global demand for goods, especially electronics, is starting to weaken in the face of inflation squeezing consumers’ disposable incomes, and services recovering the share of spending lost to good goods during the pandemic.
The purchasing managers’ index for April showed that manufacturers’ employment intentions declined. That was also true in services, but it was the eighth drop in nine months for manufacturing. Premier Li Keqiang has promised to intensify efforts to stabilise the job market and expressed concern about the ‘grave’ outlook. The dotted line between unemployment and social instability always looks to top leadership to be short and threatening.
As Li indicates, monetary and fiscal policy is being selectively loosened, and there is likely more to come. Yet the latest trade figures add weight to arguments that the economy may grow little in the second quarter and might even contract.
The bind authorities find themselves in is that meeting the target of 5.5% GDP growth this year depends on the lockdowns easing substantially by the middle of the year. Under- and ineffective vaccination and the political dynamics of doubling down on the zero-Covid policy make that an impossibly tight deadline.
THE WORLD BANK has trimmed its GDP growth forecast for China this year to 5.0%, 0.4 of a percentage point lower than its previous forecast made in October last year. The Bank says that growth could slow to 4.0% on a worst-case basis.
The new numbers are contained in the Bank’s latest update to its economic forecasts published ahead of its joint Spring meeting with the International Monetary Fund.
The reasons for the growth downgrade are familiar: a spike in Covid-19 infections causing strict lockdowns and disruption of supply chains, continuing strains on overleveraged property developers, the Russian invasion of Ukraine raising commodity prices, and tightening US monetary policy.
The Bank also highlights China’s structural slowdown and regulatory regime change.
It has this to say about China’s approach to containing Covid-19:
Eliminating CoViD-19 infections through a combination of testing-tracing-isolation and targeted shutdowns entailed a relatively small economic cost when the COVID-19 variants were less infectious. However, the highly transmissible but seeming less potent Omicron variant has increased the economic costs and reduced the health benefits of an elimination strategy. Both services and manufacturing PMis dropped in January reflecting CoViD-19 flare-ups and strict control under Beijing’s zero CoViD strategy.
Despite the changing tradeoffs, China is maintaining the strict strategy, perhaps because (a) tolerating low levels of infection may not be a stable equilibrium, (b) a spike in infections could overwhelm China’s limited health capacity in rural areas, and (c) the omicron variant may still have serious health consequences for China’s population because it has suffered fewer prior infections and been inoculated with a less effective vaccine.
The Bank estimates that the impact of pursuing zero-COVID will likely be to reduce 2022’s output by about 0.6%.
A longer-term Covid-related question raised by the Bank is whether the interruption caused by the pandemic to the trend decline in China’s share in the final-goods imports of the United States and the rising sourcing of intermediate goods from China by regional countries is temporary or not.
Thre is a huge political incentive for officials not to report Covid-19 deaths, given Beijing’s doubling down on its narrative that its zero-Covid policy in prioritising saving citizens’ lives is superior to the West crass re-opening at any cost. That and ultra-narrow criteria for ascribing a death to Covid make it highly likely that Covid-19 deaths have been undercounted on a scale in China that far exceeds undercounting elsewhere.
Local officials have long suspected overcounting economic activity, although much less so of late. Yet every tallying muscle must have been strained to record 4.8% y-o-y GDP growth in the first quarter and 1.3% growth from the final quarter of 2021. Private economists had forecast around 3.5% and barely 1.0%, respectively.
It may well be that growth was sufficiently strong in the first two months of the quarter that it offset much of the sharp slowdown evidenced by March’s drop in retail consumption and slowing industrial output and investment spending. (It is also prudent to remember that these are preliminary data that may yet get revised.)
Retail sales contracted 3.5% from a year ago, the first decline since July 2020; industrial output growth decelerated to 5% from the 7.5% expansion in January-February. Investment growth also slowed to 9.3% in the first quarter from 12.2% in the first two months of the year.
The relative strength in industrial production and investment is surprising given the already-reported weakness in some of the sector numbers underpinning them, such as sharp falls in car and cement production.
The economic damage inflicted by Covid lockdowns would have intensified toward the end of March, with Shanghai going into lockdown on March 28. A group of economists at Chinese and US universities estimated that a month-long lockdown of the city would cut 2.7% off national GDP for the month.
Shanghai is now entering its fourth week of a lockdown that has closed many factories. The longer the lockdown-induced impacts on production drag on, the larger the spillover effects through supply-chain disruptions on the rest of the economy.
Beijing will be anxious to minimise those given the multiple headwinds the economy is facing, few, such as the Russian invasion of Ukraine with its consequent impact on commodities prices, within its control.
The Ministry of Industry and Information Technology has sent a team to help more than 600 companies in Shanghai restart operations, including those producing computer chips, cars and car parts, medical supplies and equipment and pharmaceuticals. ‘Closed-loop’ bubbles for industrial workers will be imposed. Limited production at plants supplying Apple and Tesla resumed this way over the weekend.
Less easy to address and politically more concerning is the rise in unemployment the lockdowns are causing. At 5.8% in March, joblessness was at its highest level since the early part of the pandemic.
The economy is likely to get worse in April before it gets better. China’s ambitious goal of 5.5% GDP growth for the year looks distant. Increasingly frequent warnings from top leadership about the economic headwinds from geopolitical tensions, inflation pressures and slowing external demand underline this.
More monetary and fiscal stimulus is inevitable to bridge the economy to the point where more effective vaccination can relieve the necessity for economy-sapping lockdowns to contain a virus whose increasingly contagious if less deadly mutations are outrunning zero-Covid’s capacity to contain them.
THE PEOPLE’S BANK OF CHINA (PBOC)’s announcement that it was cutting banks’ reserve requirement ratio by a quarter of a percentage point from April 25 was well signalled.
It is likely the first in a series of small stimulus measures as authorities seek to counter the slowing of the economy in the face of the country’s worst wave of Covid outbreaks and soaring food, energy and metals commodity prices due to the war in Ukraine.
Premier Li Keqiang has stressed the need to ensure that economic growth picks up in the second quarter. Economic stability is the new watchword.
Monday’s first-quarter preliminary GDP figures are unlikely to make pretty reading. Year on year growth is expected to slow from 4.0% to around 3.5%, and quarter-on-quarter growth from 1.6% to barely 1.0%. The accompanying industrial production and retail sales numbers will also likely be soft.
Beijing will find it difficult to reach its 5.5% growth target this year, but there is no sign yet that it will be jettisoned.
THE PECKING ORDER of the priorities laid out by the Financial Stability and Development Committee (FSDC), China’s top financial policy committee, on March 16 is probably stability, economic stimulus and greater clarity on the regulation of the platform internet companies.
The readout from the meeting, chaired by Vice Premier Liu, also represents a short-term order of business in response to some unexpectedly gusty economic headwinds rather than a long-term change of policy course — an effort to stabilise financial markets and bolster investor confidence.
There is nothing in the reports of the FSDC’s deliberations to suggest private companies will not have to align themselves with government policy objectives or that current policy objectives have changed materially.
On the contrary, financial institutions were told to ‘consider the big picture’ and firmly support the development of the real economy, while regulators were told to complete the ‘rectification’ of the platform internet companies soon and with transparency, not to ease off them.
Nonetheless, investors in Chinese financial markets chose to see only light at the end of the tunnel, not the darkness surrounding them of late. The CSI 300 Index of mainland shares climbed 4.3%, while the Hang Seng China Enterprises Index jumped 13% in Hong Kong, recouping nearly half of its loss this year.
The China Banking and Insurance Regulatory Commission encouraged bank subsidiaries, asset managers and insurance companies to increase their investment in equities. The People’s Bank of China said the risks in the real estate market must be dealt with ‘under the principle of steady progress’. The finance ministry let it be known that there would be no further expansion of the property tax trial this year, regardless that President Xi Jinping in a speech last October indicated that a national property tax would be a centrepiece of ‘common prosperity’ .
Going even slower on deleveraging the real estate sector and introducing a property tax is a sign of how worried authorities remain about the housing market’s slump, the intractability of developers’ debt and their potential knock-on effects for the broader economy.
Despite regulators relaxing M&A funding rules and being more permissive towards developers taking on new debt, reversing the squeeze on financing for property developers, potential buyers have remained cautious. It has only really been state-owned banks buying up their clients’ distressed deals.
Reuters news agency has reported that in Shanghai, authorities told local state-owned enterprises (SOEs) to buy new bonds being sold by Greenland, a developer at risk of defaulting on a $500 million offshore bond in December. Reuters says this is the first known example of SOEs being ordered to participate this way in a bailout.
The war in Ukraine poses further challenges to an economy also dealing with an uncertain global economy, the effects of the most menacing surge in new Covid cases since the pandemic’s earliest days at the start of 2020, and the unexpected outflow of capital when other emerging markets are attracting it.
At the Two Meetings earlier this month, authorities made it clear that some long-term economic reforms would be put off for now in order to focus on growth this year. Even before then, at the Central Economic Work Conference at the end of last year, stability was the watchword.
Stability will matter more than ever in the Party Congress in the autumn. Investors should remember that their sentiment is also expected to fall in with that cause.
CHINA WILL NOT be immune from the global economic impacts of the Ukraine crisis.
Higher prices for energy and food and metals commodities — Russia and Ukraine are significant producers of all three — will raise inflation, providing a drag on real GDP growth. Almost certain recessions in Ukraine and Russia due to the fighting and sanctions, respectively, and an intensification of existing bottlenecks in global supply chains for raw and intermediate goods will exacerbate the impact.
It is too early to know the severity of these shocks, given their dependency on the outcome of the crisis. However, some scenario-based estimates are being made.
One set that crosses this Bystander’s desk comes from The Conference Board, a US business research organisation, which produced the chart above. Assuming an oil price averaging $125 a barrel in the second quarter of this year, The Conference Board estimates that China’s GDP growth for this year will be reduced by between point two and point five of a percentage point and by the same amount in 2023.
By comparison, the comparative numbers for the world economy are reductions of 0.4-0.9 percentage points and 0.1-0.3 percentage points, respectively.
Long-term energy contracts and the likelihood of buying more discounted Russian energy and agricultural commodities such as wheat that Moscow will not be able to sell into sanctioning markets will somewhat mitigate the impact on China. Nonetheless, the Conference Board is forecasting a 0.5-1.5 percentage points increase in year-on-year consumer price inflation in China for this year and a 0.1-0.8 percentage points increase in 2023.
Those will be unwelcome numbers for authorities already struggling to tame politically sensitive energy and food price rises.
The Ukraine crisis will add to the challenge of meeting the newly announced target of 5.5% GDP growth for this year. That was already looking ambitious. Headwinds from the real estate slump, the cost of the zero-Covid tolerance policy and the measures imposed by the United States to limit Chinese access to US capital, technology and intellectual property are already slowing the economy’s momentum.
CHINA HAS SET a GDP growth goal of around 5.5% for this year, a target that suggests more stimulus is likely given the headwinds from the housing market slump, the zero-Covid tolerance policy and global risks, notably the fallout from Russia’s invasion of Ukraine.
The growth goal, announced by Prime Minister Li Keqiang as part of his work report to the National People’s Congress. is the lowest in more than 30 years.
It is on Beijing’s long-term glide path to get the economy to a sustainable level, but also reflects the slowing momentum of the economy’s post-pandemic recovery.
Li’s comments at the opening of the congress suggest the central bank will cut interest rates modestly but repeatedly.
The work report also said that the budget deficit will be narrowed to 2.8% of GDP this year from last year’s target of around 3.2% and that there is a goal of adding more than 11 million urban jobs in 2022 to keep the unemployment rate under 5.5%.
The target inflation rate is around 3%, and stability remains a high priority. Increased spending by local governments is a likely channel of stimulus, with a total of 3.65 trillion yuan ($580 billion) in new special local government bonds to be sold this year, the same as last year, suggesting more infrastructure investment to sustain growth.
President Xi Jinping will want to go into the Party Congress later this year, when he is expected to be confirmed for an unprecedented third term, with a stable economy.
THE INTERNATIONAL MONETARY FUND Fund has sharply lowered its forecast for China’s economic growth in 2022, pointing to the continuing ‘retrenchment of the real estate sector and slower-than-expected recovery of private consumption’.
In its newly published update to its World Economic Outlook, the Fund is forecasting GDP growth of 4.8% for the year, 0.8 of a percentage point lower than its previous forecast in October.
The IMF says that disruption in the housing sector has been a prelude to a broader slowdown.
With a strict zero-COVID strategy leading to recurrent mobility restrictions and deteriorating prospects for construction sector employment, private consumption is likely to be lower than anticipated.
For 2023, the IMF sees a modest recovery to 5.2% growth, but that is still one-tenth of a percentage point less than anticipated in October.
The main downside risk that the IMF sees is the crisis in the property sector dragging on as policymakers continue to lower the debt level in the economy.
The baseline assumes a significant moderation in real estate investment growth in 2022, reflecting continued tight policies to rein in risks related to leveraged property developers. If the real estate slowdown intensifies further and balance sheet stresses spread beyond property developers, exposed banks and other financial intermediaries may be forced to shrink credit to the broader economy. Such an outcome would hold back investment and consumption, dragging overall growth lower with adverse implications for commodity exporters and other emerging markets.
Should that happen it would have spillover effects in the region. Emerging-market assets are already under pressure from inflation, the policy outlook and expected monetary tightening by the US Federal Reserve.
Overall, the IMF expects global growth to slow to 4.4% this year from 5.9% in 2021, which is half a percentage point lower for this year than in its October outlook.
CHINA HAS CUT interest rates for the first time in two years as the property sector debt crisis and a resurgence of Covid-19 weigh on the economy.
Fourth-quarter GDP growth came in at 4.0% year-on-year, its slowest pace of growth in 18 months. Quarter-on-quarter growth was 1.6%, up from the third quarter’s 0.7% but still far from robust.
While both the y-o-y and q-o-q numbers slightly exceeded consensus expectations, they confirm the return to the trend slowdown in growth seen before the distortions of the pandemic.
Year-on-year growth slowed in each quarter last year, although the economy expanded by 8.1% for the full year as it bounced back from 2020’s initial outbreak of Covid-19. The official target for 2021 was ‘over 6%’.
Retail sales rose by only 1.7% in December, much less than forecast, as new Covid-19 outbreaks forced new lockdowns in several cities. Investment also slowed, although industrial output rose.
The interest rate cuts by the People’s Bank of China signals a more assertive monetary approach than the easing already seen in the third quarter with the lowering of banks’ reserve requirement ratios.
Today’s cut in the benchmark one-year loan prime rate by ten basis points to 2.85% and the rate on seven-day reverse repurchase agreements to 2.1% follows December’s five-basis-points cut in the one-year policy loans rate. The five-year loan prime rate, the benchmark rate for mortgages, was left unchanged, but a reduction in that sooner rather than later would not be a surprise.
The reverse repo rate cut is the more unexpected of the latest cuts. It reflects authorities intention to stabilise the economy well ahead of the Party congress later this year when President Xi Jinping will likely be anointed to a third term.
A managed slowing of growth to rebalance the economy is politically tolerable, providing it comes with no social disruption. However, a property sector collapse with widespread developer defaults and the financial and social risk that would bring would not be.
The debt overhang remains serious. Corporate debt was still 156.8% of GDP in the second quarter of 2021. That is down from 163.4% a year earlier but still high enough to complicate the way forward for policymakers aiming to stimulate growth while reducing the economy’s reliance on debt-fuelled infrastructure investment and export-oriented manufacturing.
THE WORLD BANK has trimmed half a percentage point off its estimate for China’s GDP growth last year and three-tenths of a percentage point off its forecast for this year and remains concerned about the risk of a prolonged downturn in the property market.
In the latest edition of its Global Economic Prospects, the Bank estimates China’s economy grew by 8.0% last year, down from the 8.5% forecast in June 2021. It forecasts 5.1% for 2022, down 5.4%, reflecting the lingering effects of the pandemic and additional regulatory tightening. It is holding its 2023 forecast unchanged at 5.2%.
Its forecast for this year is in line with China’s slowing trend growth.
In its commentary, the Bank says that manufacturing activity has been solid despite supply disruptions and electricity shortages, and export growth has accelerated, even as Covid-induced lockdowns and curbs on the property and financial sectors have restrained consumer spending and residential investment.
For now, macroeconomic policy measures have forestalled a sharper economic slowdown and mitigated financial stress. The People’s Bank of China has reduced reserve requirements, lowered its one-year loan prime rate and implemented significant short-term liquidity injections. The government has accelerated infrastructure investment, supported homeowners and creditworthy developers, and accelerated local government bond issuance.
However, looking ahead into this year, the Bank expects the effects of the pandemic and tighter sector-specific regulations to linger, with policy support only partly offsetting that. It also remains concerned about the possibility of a marked and prolonged downturn in the property sector—and its potential effects on house prices, consumer spending, and local government financing. It describes this as ‘a notable downside risk’ to its forecasts.
In China, financial stress could trigger a disorderly deleveraging of the property sector. Property developers such as China Evergrande have collectively accumulated financial liabilities approaching 30 percent of GDP. Moreover, corporate bonds issued by property developers accounting for a third of the sector’s liabilities have recently been trading at distressed prices. A turbulent deleveraging episode could cause a prolonged downturn in the real estate sector, with significant economy-wide spillovers through lower house prices, reduced household wealth, and plummeting local government revenues. The banking sector—local banks in particular—would be significantly impaired, raising borrowing costs for corporations and households.
Should that come about, the impact would be felt well beyond China. The financial stress would quickly reverberate across the region’s emerging markets and developing economies. The knock-on effect would be the risk of capital inflows suddenly drying up, triggering currency crises, especially in any country dependent on short-term inflows to finance its current account deficit.