China to engage in more expansionary policies but without rocking the boat

After achieving strong growth in the first half of 2021, China’s growth prospects are turning for the worse. Economic data in July points to a rapid slowdown with weaker consumption and investment. As if it were not bad enough, the sudden outbreak of delta virus in several Chinese cities and the related measures to restrict mobility should further hit consumption, especially services.

While it is very likely that China will control the virus, the uncertainties about potential virus mutation will continue to weigh on sentiment and, thereby, potentially investment and consumption of durable goods.

But China still has bullets in the pocket, namely room to conduct more stimulus, whether fiscal or monetary. As the US and the EU were easing policies to support their struggling economy, China took a more conservative policy stance thanks to the strong rebound of the economy after the initial shock. The trend was clearly observed in the first half of 2021.

On fiscal policy, the year-to-date fiscal deficit until July 2021 was only RMB 21 billion, which was not only far lower than that of the first seven months of 2020 (RMB 1.9 trillion) or that of 2019 (RMB1.2 trillion), but also far from the annual target of 3.2% of GDP set during the latest key government gathering - the Two Sessions - in March this year (Chart 1). The year-to-date deficit for the government fund was also lower than that of the previous years, only 240 billion until July compared to the corresponding deficit of 1.4 trillion in July 2020 and 576 billion in July 2019 (Chart 1).

On monetary policy, the total social financing, a key market liquidity indicator, also kept decelerating from the beginning of the year, especially in terms of corporate bond finance and the still tightened off-balance sheet shadow banking finance (Chart 2). As such, Chinese government seemed to have tilted its policy priority this year from boosting growth to containing financial risks over the past half year.

So, the question is really whether China will change its policy stance in the second half of 2021? On the positive side, there are plenty of reasons for the government to do so. First, the policy bullets are intact so that debt dynamics have improved this year with the debt-to-GDP ratio decreasing from 272% at the end of 2020 to 267% in Q2 2021).?Second, some easing on the monetary front has started with the PBoC cutting the Reserve Requirement Ratio (RRR) in early July. Also, the fiscal spending is likely to accelerate as the Politburo Standing Committee specially mentioned that the issuance of local government’s special purpose bonds would be stepped up at the end of July.

On the negative side, we do not really see the impact of the policy easing. So far, the sales of excavators, a leading indicator for infrastructure investment, remained sluggish at -9.2% in July (Chart 3), which means that infrastructure investment may still take time to fully pick up. Furthermore, the time remaining for infrastructure investment to make a difference in 2021 growth is short, so most of the impact will only be seen in 2022. Finally, it is difficult for the government to backtrack on its earlier targets on containing financial risks.

With such pros and cons in mind, we do expect laxer monetary and fiscal policies for the rest of the year but still keeping a cautious approach, especially when it comes to certain sectors such as the real estate. This relates to the increasingly important objective of “common prosperity” which is shadowed by the concerning housing affordability for Chinese households. In other words, smaller policy steps (clearly easing ones in the second half) will become the norm, as summarized in China’s policy makers’ new buzzword, cross-cyclical policies. The latter differs with the counter-cyclical policy mantra, and echoes China’s intention to reach decent growth rate while avoiding long-term financial risks. We set the growth rate of 7.8% for 2021 a year ago and still keep it as it remains in line with our earlier expectation of a slower growth rate in the second half of 2021.

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