China: Demand has returned but the manufacturing sector is yet to catch up

Chinese economy bounced back to 4.9% in Q3, faster than in Q2 (3.2%), after the government successfully contained the spread of the Covid-19 and reopened domestic activities. The faster growth in the third quarter echoes the upbeat in business sentiment. Still, 4.9% growth is below market expectation and also below our own expectation based on nowcasting tools (See: Nowcasting China’s GDP: What to expect in Q3 2020).

On consumption, retail sales continued climbing up to 3.3% YoY as consumer began to regain purchasing power on the back of rising income. The disposable income grew 0.6% (in real terms) in the first three quarters from only -1.3% in H1 2020. Unemployment rate also declined to 5.4% in September. However, the consumption recovery is not complete as the year-to-date retail sales is still 7.2% lower than last year.

Fixed asset investment also improved in September and its year-to-date growth for the first time of the year turned positive. However, it was mainly from the public sector with an increase of 4.0% while the private investment remained sluggish. Furthermore, most of the pulling effect in investment stemmed from property and infrastructure sectors as they reached new high by growing 5.6% and 0.2% respectively since the beginning of the year, whereas the manufacturing investment has been recovering more slowly and remained -6.5% as compared with last year.

Another bright spot of Chinese economy was the exceptional performance in exports, which sustained strength in Q3 and jumped to 9.9% in September. Imports were much weaker in the first two months but rebounded to grow 13.2% in September, in line with faster domestic consumption. Overall, the trade balance moved from a large surplus in the first two month’s of the quarter to deficit in September.

As regards macroeconomic policies, the PBoC seemed satisfied with the recent progress of the economy and put the RRR and the interest rates for reverse repo and MLF on hold throughout Q3. This has pushed 3M SHIBOR to further rise to 2.8% as of 19th October. The big interest rate differential with US money market rates has caused large portfolio inflows into Chinese fixed income and, possibly, recent rapid appreciation RMB. That said, the PBoC still injected liquidity from time to time to stabilize the overall funding cost for corporates. The current wait-and-see approach to monetary policy is likely to continue so as to leave room for policy tools in case the recovery falters.

Because of the improvement of economic conditions, China’s general government fiscal revenue increased significantly by growing more than 18% in July, leading to fiscal surplus. Still, the accommodative fiscal space remained in place and the deficit widened again in August (the latest figure so far) even though the magnitude of the deficit was much smaller than the peak in March.

Looking forward, we expect the Chinese economy to continue improving if the government can continue to keep the pandemic under control, offering an accommodative environment for economic activities. The challenges ahead, though, is whether, and to what extent, household disposable income could be further lifted to speed up consumption. Another key issue to observe is how China’s manufacturing sector can recover against the backdrop of a still weakened global economy and an increasingly hostile external environment, especially amid the strategic competition with the US and the general push for the reshuffling of global value chain. All in all, given the weaker-than-expected GDP performance in Q3, we have revised our GDP forecast for 2020 slightly downwards to 2%.

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