A disappointing second quarter for the Chinese economy, with GDP narrowly avoiding a contraction, could mark the low point of this cycle (regardless of the decline in activity caused by the pandemic in the first quarter of 2020). However, even with massive government support for the economy and an easing of Covid-related restrictions, any recovery looks set to be gradual at best. The official growth target of 5.5% for 2022 therefore risks not being achieved.
With just 0.4% year-on-year growth, GDP growth in the second quarter of 2022 slowed sharply from the pace of 4.8% already below the target recorded in the first quarter. Beijing has already stepped up its economic easing measures to stimulate growth and has introduced more flexibility into its zero-Covid policy.
However, containment measures aimed at containing the spread of the virus continued to hamper activity. Other headwinds include the recent boycott of mortgage repayments by unfinished home buyers as developers struggle to stay afloat. At this stage, the impact of this boycott remains uncertain.
We therefore do not expect V-shaped growth to rebound in the second half of 2022, although we believe the medium-term outlook tends to improve.
Growth target not achieved
Even if GDP were to grow by 5-6% in the second half of the year (which we believe is an optimistic assumption), growth for the full year should be well below the official target (see Figure 1). . The market consensus for growth in 2022 is between 3% and 4%.
In June there were signs of recovery amid the easing of the restrictions linked to Covid and the support to activity provided by macroeconomic policy.
In particular, industrial production grew by 4.0% on an annual basis (compared to only 0.7% in May) thanks to the increase in the volumes of vehicles and electrical equipment produced. Driven by the good performance of auto and food sales, retail sales increased by 3.1% (after -6.7% in May). Fixed assets investments increased by 6.0% (compared to 4.7% in May), supported by an increase in infrastructure investments of 13%.
Support for economic policy and risk
The easing of the policy announced after the April Politburo meeting and the continued easing of the containment measures have allowed the Chinese stock market to enjoy a nice rebound since the end of April. This improvement recently ended after a spike in new Covid cases linked to a sub-variant of Omicron in several cities (Figure 2).
Overall, Beijing has stepped up its support measures since the second quarter by speeding up the issuance of special bonds for local governments, expanding tax exemptions, injecting more liquidity into the economy and easing its measures in the real estate sector.
Extending this easing is likely to require additional infrastructure spending1 and new funding. Infrastructure investments are already showing a strong recovery. The funding will include RMB 1.5 trillion additional issuance of local government special bonds over the 2023 quota, loosening local government financial vehicle (LGFV) financing conditions and increasing volumes of strategic bank lending. (estimated at RMB 800 billion) for environmental projects.
Unlike most countries in the world, high inflation is less of a problem for China. Since 2013, main consumer price inflation has averaged around 2.0% yoy and core inflation around 1.5%.
This allows China to conduct an accommodative monetary policy, in contrast to the tightening taking place in the rest of the world. As a result, the overall amount of loans recovered (Graph 3) and the DR-007 money market rate remained well below the People’s Bank of China’s 2.1% target.
From our point of view, the greatest risk to growth lies in the zero Covid health policy. The resulting uncertainty weighed on the production and supply chains, on mobility and above all on capital goods and consumer goods.
Loss of consumer and business confidence and economic disruptions are problems that monetary easing will not easily solve. Therefore, we expect Beijing to step up fiscal stimulus with the aim of directly increasing aggregate demand.
What has changed?
After more than a year of tightening regulations related to technology and related industries, this headwind to growth could ease with the conclusion of surveys of major fintech and e-commerce companies. Future regulatory reform will likely focus on implementing economic policy rather than introducing new laws. This should allay much of the political uncertainty in these areas.
The greater flexibility seen since June in the fight against Covid could also translate into further relief. Lockdowns are now quick and targeted, while quarantine periods have been reduced. Only non-essential services are suspended. PCR tests in high-risk areas are more frequent and low-risk areas are reopened more quickly.
This new approach is expected to mitigate the general disruption caused by blockages, help protect supply chains and reduce political uncertainty.
However, the growing number of homeowners who no longer repay their mortgages represents a new growth risk. These are homes negotiated in presale without being completed or delivered, as the developers have run out of cash.
As these presales have greatly increased developer leverage, extending this boycott of home loan repayments could create a credit crunch for developers and lead to defaults in offshore US dollar bond markets (on which these promoters have borrowed a lot). It could also result in more bad loans on the balance sheets of local banks.
There is a risk of contagion: rising home loan defaults could undermine the confidence of homebuyers, which would have the effect of further reducing home sales and forcing more developers to put their projects on hold. This could then lead to more mortgage defaults, creating a vicious circle in the real estate sector.
What can Beijing do?
To contain the systemic risk, Beijing could ease further its policy towards the real estate market, even if a general bailout seems unlikely.
In addition to the abundance of liquidity, the authorities can mobilize the resources of local authorities, public enterprises and LGFVs to revive pending projects and preserve household confidence. This would send the message that the completion of housing is a top priority. Public developers could also buy struggling players to eliminate bad apples and help solidify the housing market.
Recently, regulators asked the China Construction Bank to set up a fund to buy real estate projects under construction and convert them into long-term rental apartments. If this practice were implemented on a larger scale, it could resemble a “Trouble Asset Relief Program” (TARP) of the type that the US government initiated after the financial system crisis of 2007-2008. program aimed at purchasing toxic assets and stabilizing the financial system.
Reallocation to Chinese assets
This intersecting macroeconomic turbulence could lock government bond yields to between 2.8% and 3.0% in the coming months, with their rise limited by growth and monetary policy concerns. recovery of the credit impulse.
In the short term, political risk is likely to fuel volatility in Chinese equities. But at the same time, the market welcomed the good news nationwide, including the less stringent Covid policy, setting the stage for an eventual recovery.
In our opinion, the medium-term prospects appear brighter for China than for the West, where clouds have begun to thicken both in the United States (in recession) and in Europe (which suffers from its energy dependence on Russia).
So, in relative terms, the divergence of China’s monetary and growth policy from the West could lead investors to reallocate their capital into China-related assets in due course.
1 As we pointed out recently, China needs, in addition to monetary easing, a Keynesian solution to save its growth. See ” About Flash: Save China’s Economic Growth », April 25, 2022.
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