A rare spot of hope in a year marked by the pandemic
News that China’s economy expanded by 2.3% in 2020 injected much-needed cheer into the financial markets last month, making it the only major economy in the world that managed to post meaningful growth in a year marked by the COVID-19 outbreak. However, we believe the cyclical recovery in China may have peaked—the main drivers behind last year’s growth, massive monetary and fiscal stimulus, debt expansion, and an export boom, are in the midst of reversing course. We see downside risks to current consensus forecasts for Chinese GDP growth (which calls for an 8.4% year-over-year growth 2021 and a 5.5% expansion in 2022) and expect these forecasts to be downgraded in the coming months.¹
China’s policy approach: a recalibration
China signaled a relatively less supportive policy approach at its annual Central Economic Work Conference in December, aiming to target reasonable monetary policy and noted that the country’s fiscal plans should be sustainable over time. While the main thrust of the government’s communication remains consistent (i.e., no sharp policy U-turns and continued “necessary support for the recovery”)² for those of us who’ve been following China for a long time, the incremental shift in tone is obvious. And indeed, the latest economic data—from the credit impulse to Purchasing Managers’ Indexes (PMIs)—is beginning to reflect the recalibration in the government’s approach to policymaking.
The People’s Bank of China (PBOC) has reversed most of the monetary easing it had implemented in the past year. For instance, short-term interbank rates rose sharply in recent weeks, hitting levels not seen in five years. By deciding against providing additional liquidity to the market, the PBOC has effectively “endorsed” the rise in short-term interbank rates.³ In fact, the central bank has been, in net terms, withdrawing liquidity through its various monetary policy tools year to date, which could have negative implications for GDP growth. This shift in policy stance has already begun to weigh on credit growth, which has been slowing since November.
Mapping net liquidity level against monthly GDP tracker
We’re seeing similar developments on the fiscal front. In contrast to recent years, the central government hasn’t authorized advanced borrowing quotas for local governments ahead of the annual National People’s Congress session in March. Notably, in a departure from what it’s done in the last two years, authorities have yet to announce how much local governments can borrow from the bond market in 2021⁴—a sign of fiscal tightening. The absence of market activity is also telling: There hadn’t been any local government bond issuance in January 2021, compared with 418 billion yuan in January 2019⁵ and 785 billion yuan⁶ in January 2020. Meanwhile, policymakers have announced the rollback of many fiscal support policies; for example, social security waivers.⁷
Refocusing on reining in financial risks
Having put the deleveraging campaign on ice last year, China is now refocusing its attention on reining in financial risks—it’s an issue of growing urgency in light of existing debt levels, as debt-servicing costs have risen to record highs.
Assessing China's debt level and its debt-servicing ratio
Beijing has taken a particularly tough stance toward the highly leveraged property sector, where authorities have introduced a string of regulatory controls to clamp down on excessive speculation, including demands for higher minimum down payments, placing limits on bank lending to the property sector, and incrementally tighter financing conditions for developers.⁸ Since the property sector is a key pillar of China’s economy, slower property investment represents another downside risk to GDP growth this year.
Export boom unlikely to carry over through 2021
Coronavirus disruptions around the world fueled strong demand for Chinese goods in 2020, resulting in a string of record monthly trade surpluses in China, boosting GDP growth. Export strength was concentrated in personal protective equipment, electronics, furniture, and recreational goods for home use, filling gaps left by supply-and-demand imbalances from lockdowns abroad. Unsurprisingly, China’s share of world exports hit a record high in 2020.¹ Encouraging as it may be, we don’t expect China’s net exports to continue their winning streak. Put simply, a global economic reopening is likely to present a headwind to Chinese exports as these disruptions unwind.
"Taking into account all the available information, it’s logical to conclude that China’s economic recovery might have peaked and growth is likely to moderate."
Chinese manufacturing activity has reversed sharply with foreign demand now slowing as a result of pent-down demand, where one-time consumer purchases of durable goods/household appliances/home entertainment systems has hit a saturation point. We expect this trend to accelerate if vaccines prove successful, which would enable normalization in other major economies and therefore lead to increased global competition; or if we were to see a broadening in protectionist measures globally that could limit global demand for Chinese goods. Meanwhile, Chinese exporters are reeling from the strengthening Chinese yuan, which is trading at levels not seen since June 2018 against the U.S. dollar,1 as currency mismatches hurt their bottom line.⁹
Taking into account all the available information, it’s logical to conclude that China’s economic recovery might have peaked and growth is likely to moderate. It’s true that the weeks ahead could yet yield some policy surprises; however, it’s likely that the news flow going forward may not be as positive as consensus expectations might suggest.
1 Bloomberg, as of February 3, 2021. 2 “China Targets ‘Reasonable’ Monetary Policy as Economy Recovers,” BNNBloomberg, December 19, 2020. 3 “China's o/n repo highest since March 2015, busts PBOC corridor ceiling,” Reuters, January 29, 2021. 4 “No Sign of China’s Bond Quota as Government Looks to Curb Debt,” Bloomberg, January 13, 2021. 5 “China bond issuance reaches 3.2 trln yuan in January,” xinhuanet.com, February 23, 2019. 6 “Local gov't bonds worth 785 bln yuan issued in January,” xinhuanet.com, February 23, 2020. 7 cctv.com, December 10, 2020. 8 “Beijing turns the screws on China’s property sector,” Financial Times, January 26, 2021. 9 “A stronger RMB impacts China’s exporters,” cgtn.com, December 7, 2020.
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