Shuang Ding, Chief Economist, Greater China and North Asia at Standard Chartered Published in June 2020
As China puts job creation and social stability at the centre of its plan to recover from the impact of COVID-19, what’s the outlook for the world’s second-largest economy? Here is our analysis of the government’s response, the key risks and the reasons to be optimistic.
While China’s economy is a long way from where it was before the pandemic hit, we believe that there are positive signals in much of the domestic data. Officials are firmly focused on protecting employment, livelihoods, businesses, and supply chains, as well as on utilising expansionary macro policies - putting the economy on a firm footing as it heads into the second half of the year.
China’s government is prioritising social goals ahead of GDP growth by creating employment and indicating that fiscal policy will be its preferred way to stimulate the economy. Officials have suggested that they are willing to almost double the budget deficit to support gross domestic product growth, while allowing money supply and credit growth to reach higher levels. There also appears to be a clear shift in China’s strategy; moving from an export focus to paying greater attention to domestic demand, to releasing consumers’ potential, and investing in new and traditional infrastructure projects.
Standard Chartered’s monthly proprietary survey of small and medium sized businesses in China shows a recovery gaining traction. The gauge rose to 51.7 in May from 50.9 in April, and the ‘current performance’ sub-index indicated expansion for the first time in four months, suggesting an acceleration in real activity. SMEs were also optimistic about their prospects.
While the latest data shows that China’s economy shrank 6.8 per cent in the first quarter compared with the same period a year earlier, there has been an improvement in momentum and in the leading indicators in recent months.
Even so, the recovery is not even. As large companies fare better than others, policy is tilted toward supporting SMEs, with measures including temporary tax and fee cuts and an option to delay corporate income tax payments until the first quarter of next year. SME access to credit has improved, and more policy support is likely to bring down the cost of borrowing.
Shoring up consumer confidence, spending and the services sector is key to fostering demand, and the government’s focus on stimulating employment shows they are cognisant of this.
Risks to the domestic outlook include a potential recurrence of the virus, a stronger propensity to saving and a rise in non-performing assets at banks.
While we see the debt-to-GDP ratio climbing by around 20 percentage points this year, the risk is manageable as long as it represents a temporary spike in response to the unprecedented growth challenge.
The stimulus measures should support a gradual recovery for the rest of the year, and in our base scenario, the economy could grow at a rate of between 2 per cent and 3 per cent this year.
At the same time, we recognise that while supply resumption is encouraging, export side weakness is a major downside risk to growth. Standard Chartered’s SME survey showed export orders were still contracting in May and overseas demand remained sluggish.
Moving ahead,China can’t rely on short term economic stimulus and should also stimulate the creativity of the private sector and enhance productivity.
We are cognisant that external risks, such as trade tensions and a deeper global recession, are the biggest threats to the outlook and could put a brake on growth. Also, in the run-up to the US presidential election, blaming China has become a common strategy of both the Republican and Democratic parties, and bilateral tension could escalate on trade, investment, technology and geopolitical issues.
Should domestic and external risks materialise, growth will be lower than our central forecast. Our scenario analysis shows that if a second wave of the virus hits and the external environment and trade tensions worsen, then GDP may contract by as much as 0.5 per cent this year.
While anti-China rhetoric is likely to continue in the run-up to the US election, both sides have an interest in keeping the Phase One trade deal announced earlier this year intact, and both are likely to weigh the costs and benefits of any further action carefully.
Domestic fundamentals and government stimulus should help guide China back to a firm footing.
Much of the recent data looks comforting and the capital and currency markets show relative stability. Standard Chartered’s renminbi internationalisation tracker rose in March, suggesting resilience and confidence among investors, even amid the disruptions.
Most workers in the manufacturing and construction sector, one of the cornerstones of the economy, have returned to their jobs as factories work to resume normal capacity and project implementation accelerates.
While the initial signs are encouraging, there’s still some distance to go before China – and the rest of the world – is out of the woods. A broadening of the domestic recovery and an improvement in the global data would help.
Should the outlook worsen, many investors believe the government will introduce more stimulus, with 84 per cent of respondents to a Standard Chartered live poll predicting this will materialise before the end of the year.
While we don’t expect additional stimulus, this may change if there are fresh signs that the economy is faltering. China’s officials are aware of the longer-term challenges of taking on more debt to fund stimulus. However, they are leaving room for manoeuvre if it is needed.
Any more stimulus is likely to be on the fiscal side, rather than around monetary policy or credit, given that the government’s priority is to generate demand. Special bond issuance could be increased if needed and further stimulus might be directed toward funding new infrastructure projects. Credit growth is already high relative to nominal GDP, and the authorities may focus on ensuring credit is flowing to the real economy instead of circulating within the financial system.
China’s economic recovery may well be unpredictable. However, there are many reasons to be positive. While risks remain - including the re-escalation of trade tensions, another outbreak of COVID-19, and a deeper global recession - the government appears prepared to deploy more of the policy tools at its disposal. The initial data is promising, and investment and consumer confidence is improving, setting in place many of the elements for good growth.
This article contains insights from the ‘Unravelling Uncertainty’ webinar series in partnership with The Economist.
