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China Economist Peiqian Liu outlines the drivers of China’s positive growth outlook and provides some insights into what to look out for from here.
The Chinese economy rebounded sharply in Q2, expanding by 3.2% year-on-year after shrinking by 6.8% year-on-year the previous quarter. In fact, as we state in our global economic outlook we think it’s going to be the only major economy to grow this year. Take a look at the chart below for our growth forecasts for various major economies.
But how has China managed to achieve this rebound? Let’s take a look before going on to consider some other factors that investors might want to consider.
First in, first out
As the first country to suffer from coronavirus, it was also the first to recover. China managed to bring the coronavirus situation under control domestically within around 6–8 weeks (11 weeks for the hardest-hit area in Hubei province) between late January and early March, and the first phases of economic recovery began in Q2.
Surge in global medical related demand
Chinese exports were once again well above consensus expectations in June, up 0.5% year-on-year (they had been expected to fall by 2.0%). Imports also returned to year-on-year growth, rising by 2.7% year-on-year – far better than the 9.0% contraction that had been expected. The total value of Chinese trade was up 5.1% year-on-year in June, suggesting that trade activities are on the road to recovery as the world’s major economies gradually reopen.
Strong demand from across the world for masks, personal protective equipment and medical supplies continue to provide support to Chinese exports. And with more economies reopening, we’ve begun to see some pent-up demand for other goods, such as mechanical and electrical goods.
Demand challenges offset by strong supply patterns and a careful policy mix
We’ve revised our forecast for Chinese economic growth in 2020 up from 1.7% year-on-year to 2.2% year-on-year as the supply-side recovery has been stronger than expected.
As you can see in the chart below, supply-side production has outpaced demand. So far, targeted easing policies have focused on helping corporates to survive and resume business activity while keeping employment stable. But corporate tax cuts and social insurance reductions have not yet benefitted consumers, who are still struggling in the shrinking jobs market.
However, the momentum of industrial sector production and state-led investments have provided more support to offset the downside pressure. We think the economy will continue to recover gradually as more fiscal easing and targeted monetary easing policies are implemented and take effect.
The external sector looks set to remain under pressure in the short term as social distancing measures to control the pandemic across the globe continue to hinder demand. In response, Chinese policymakers have announced more fiscal easing policies to support domestic demand in an effort to offset some of the external slowdown. The current policy mix is putting a strong focus on approving infrastructure projects and corporate tax cuts. This should help revive demand in the infrastructure and consumer sectors until broad economic activity gradually returns to normal.
The risks to look out for
While the outlook is positive, these are uncertain times and there are still complex challenges to navigate on the road to a full recovery. The two biggest risks we see are:
- Localised outbreaks of coronavirus: the second wave of coronavirus cases that we’re seeing elsewhere is limiting China’s ability to fully relax social distancing policies and get its economy back up to full speed as originally planned. The government is taking a cautious approach as it faces renewed threats of imported cases and recurring small local outbreaks
- An escalation of the trade and technology disputes between the US and China: China’s imports from the US rose 11.3% year-on-year to USD 56.4bn in H1, equivalent to around 25% of the total imports target under the US-China Phase I trade deal. This means that China will need to import an average of USD 27bn per month (around 2.4 times average monthly imports in 2019) over the remaining six months of the year to meet the terms of the Phase I agreement, which states that the value of goods that China imports from the US in 2020 should be at least USD 219.1bn.
As the world’s second-biggest economy, what goes on in China has a big knock-on effect elsewhere.
Global supply chain challenges: will China remain an epicentre of manufacturing? We think so in the near term.
China has enjoyed the steepest rise in manufacturing output of any country since joining the World Trade Organization (WTO) in 2001. This has made it the world’s largest manufacturing hub, surpassing the US and Japan. In the aftermath of the coronavirus, we think more companies will be reviewing the reliance on China of their supply chains. The need to have contingency plans in place and diversify so that supply chains are not so badly disrupted in the event of a future lockdown in China as they were in Q1 is entering the minds of many corporate decision-makers.
But this is no easy task. China’s manufacturing output has grown to around 27% of global output. The massive scale of China’s manufacturing infrastructure, including fixed assets invested, skilled labour and comprehensive logistics links, would make it unrealistic for companies to move manufacturing elsewhere in a short timeframe. We can see how reliant on China’s comprehensive supply chain the world has become in the form of the strong demand for medical and protective equipment during the pandemic.
If companies were to shift just 10% of their manufacturing output away from China, many countries would need to significantly increase their manufacturing capacity. This would probably take several decades. What’s more, realigning supply chains out of China would mean higher fixed costs and a lack of skilled labour for corporates.
Currency trends: will the renminbi be a mover and shaker? We think stabilisation is the focus for now.
Despite the plunge in economic activity in Q1, China’s central bank did not flood the market with aggressive monetary stimulus. In fact, China’s money supply growth in the past two quarters has accelerated by a modest 3 percentage points to 11.1%.
We believe the Chinese central bank’s relatively restrained action compared with other major central banks, coupled with a relatively optimistic growth outlook for the Chinese economy, will help the Chinese renminbi to remain stable in the medium term. The key risk is any escalation in US-China trade tensions and additional tariffs being levied on Chinese goods, although we believe the central bank would step in to slow the pace of the renminbi weakening under that scenario.