China Politburo prioritises stability in H2 2022

In this article, Carlos Casanova, our Senior Economist Asia, shares a summary of his latest Asia Macro Report.?

Q2 weakest quarter in 2022

Unlike the US where growth is slow and inflation is being fought by the Fed with rate hikes, China is exiting a period of economic weakness and is adding stimulus. After an unprecedented slump due to strict lockdowns, a recovery in activity indicators followed in June, with a surge in domestic consumption and exports.

After a rebound in retail sales favoured by pent-up demand, we expect demand for both services and goods to normalise in July as fresh lockdowns, albeit less strict, will dampen consumption and inflation is expected to increase gradually.

Although industrial production also bounced back more strongly in June, largely due to a backlog in export orders, external demand is set to turn less supportive as recession looms in the eurozone and the US.

In sum, we expect that activity indicators will return to trend in July and GDP growth will stabilise around 5.0% y/y in H2 2022. We see few upside risks to our 2022 China GDP growth forecast of 3.7%.

Housing slump

The housing market has slumped with almost all the risk concentrated in the residential sector where sales and new construction projects have plummeted by over 30% y/y. Many home buyers have stopped servicing their mortgages following reports that several developers have run out of cash.

Although the housing sector does not constitute a systemic risk, it will remain sluggish in 2022 largely due to muted sentiment, made worse by the “zero-Covid” policy preventing investment decisions, and concerns about defaults. A housing slump can have a significant effect on China’s economic growth as the sector accounts for a massive 25% of its GDP. In order to mitigate risks, the government will guarantee that the homes already paid for are delivered by extending credit to developers bailing out impacted developments.

Politburo meeting: emphasis on stability

The July Politburo meeting was decidedly not hawkish, avoiding reference to the official 5.5% growth target, and instead underscoring “stability” and pledging to uphold “dynamic zero-Covid”. Yet Beijing is not prepared to flood the system with excess liquidity to pursue growth at all costs. ??

Monetary policy is to remain broadly unchanged, with incremental easing and minimal rate cuts. The problem being sentiment rather than liquidity, what we might see is more targeted support for the housing sector with mortgage interest rate cuts, and the PBOC will continue to boost aggregate demand via faster M2 and credit growth.

In terms of fiscal policy, the Politburo meeting put most of the emphasis on previously decided measures to stabilise the economy. The plan includes extra tax rebates to around 2.5% of GDP and macroprudential tools such as allowing companies to defer social and insurance payments until the end of 2022. Infrastructure spending will also play a prominent role from Q4 2022 onwards.

Implications for investors

Sustained policy support and an improving macroeconomic environment are supportive of a gradual recovery in Chinese equities which will likely outperform global equities on a relative basis in 2022 but potential downside risks remain in relation to China’s “dynamic zero-Covid” strategy. Therefore, we prefer good-quality companies in sectors that are well aligned with policy priorities.

In contrast, fixed income investors should remain cautious as Chinese high-yield spreads should remain wide throughout 2022, skewed by the real estate crisis. ?

Lastly, the monetary policy differential with the US will remain wide in H2 2022, which could weaken the currency.

+ Read the full report on UBP.com