Has the Chinese economy already peaked in its post-Covid business cycle?

It took five quarters for Chinese economy to peak after the 2007-2008 global financial crisis (from Q4 2008 to Q2 2010). China seems to have peaked again about five quarters after taking the severe hit in Q1 2020.

The latest economic release seems to have confirmed that China is now in a stable but steady slowdown. In fact, the Chinese economy lost steam across the board in both consumption and investment in May since the base effect was less favorable than in previous months. But the double-digit growth for both indicators is still high compared to the historical average in recent years. So, the question that is more interesting to ask is what will it be like when the Chinese economy passes its peak?

The answer to the latter question is not so bleak as it may look at first sight. First, consumption recovery is still taking pace, though moving at a slower pace. If we exclude the base effect and look at the month-over-month reading (after seasonal adjustment), retail sales growth rate was 0.81% in May compared to only 0.25% in April thanks to the golden week holiday at the beginning of the month, which was also only slightly lower than the month-over-month growth rate in February and March (Chart 1). In particular, car sales were a big drag, but the other products were still growing positively.

Secondly, while fixed asset investment growth rate was much lower in May, this was particularly due to the deceleration in SOE and infrastructure investment. According to our adjusted estimate, the year-over-year investment growth for SOE and infrastructure may have already decreased to negative territory. At the same time, manufacturing and private investment also experienced a slowdown but only moderately, with the former being partly supported by the strong external demand (Chart 2). This means that, although there was market-driven cyclical slowdown, the Chinese government was also not pushing too hard to boost growth through the SOE and infrastructure projects.

Echoing the latter point on infrastructure, China’s fiscal stimulus, especially from the local government, has been rather conservative so far. The local government bond issuance was at a much slower pace compared to earlier years, reaching only 44.2% and 16.0% of the 2021 annual target for general and special bond respectively (Chart 3). Similarly, the PBoC has also taken a prudent tone in maneuvering market liquidity and interest adjustment since last year. As such, both fiscal and monetary bullets have been largely reserved in China’s policy making.

All in all, incoming data from China is largely within our expectation of a moderately strong growth (7.8%) in China for 2021. If the current trend continues, Chinese economy will slow down in line with the expectation of a much lower growth rate for the second half of the year due to the less favorable base effect as well as the decelerating support from external demand.

Having said that, an important variable that is mostly likely to prompt China’s growth is the fiscal support. The latter has so far been prudent compared to last year but also that of other major economies, especially the US. A rise in fiscal support in the second half of 2021 will have consequences in raising public debt. But taking into consideration of such a trade-off, we think China may still speed up its fiscal expansion to moderate the economic slowdown.

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