After the outbreak of Covid-19 in Wuhan during Q1 and the resulting lockdown measures implemented by authorities, the Chinese economy shrank an unprecedented 6.8% YoY in the three-months up to March.
Since the economic shock in Q1, the road to recovery has been relatively smooth by current standards, although a minor outbreak in Beijing is likely to have shaken consumer sentiment, while flooding in southern China hampered agricultural output. Despite this, China’s early outbreak and success in controlling the spread due to strict containment measures being implemented means the economy is expected to post a positive Q2 GDP reading at a time when most large economies will be in contraction. With a fiscal response around 11% of GDP once special bonds for local governments, coronavirus bonds and the effects of the stabilization fund are taken into account, combined with monetary easing, China is anticipated to lead the global economic recovery. To date, so far so good.
Industrial production fueled the Q2 rebound but don’t expect the pace to continue in Q3
Industrial production has led the economic recovery in China as authorities leaned on state owned enterprises to reignite growth. Additionally, the production side of the economy was allowed to re-open before retailing and service sectors. Ultimately, this saw a rebound in manufacturing PMIs to above the 50 level occur quicker than in the service and non-manufacturing PMIs. The influence of authorities on state owned entities is evident in the official manufacturing PMI outstripping the Caixin measure, which is wholly composed of privately owned manufacturers. Only now have the privately owned manufacturers started to expand at a rate quicker than their state owned counterparts with a reading of 51.2 vs 50.9 for June.
Industrial production leads the Chinese economic recovery with consumption lagging behind
External conditions weigh on China’s recovery as domestic demand drives the growth rebound – New export order PMIs remain below 50
Year-to-date, Industrial production output now sits just 2.8% lower compared to June 2019, after growing 4.4% and 3.9% YoY in May and April, but the rebound may not continue at such a fast rate. Chinese factories remained more reliant on domestic demand than foreign markets as lockdown measures continued to cap the rebound in global trade and foreign consumption, and therefore restricted external demand for manufactured products. Total new orders for manufactured goods rose for the first time since January, but only modestly due to another month of contraction in new export orders. Additionally, factories are likely to take a breather in Q3 and opt to work through elevated inventory levels, while the Finance Ministry has already approved the RMB3.75trn in special purpose bonds aimed at financing infrastructure bonds, meaning fiscal support is expected to wane in 21H2.
Time for the consumer to return?
With industrial output set to slow in the second half of the year, the Chinese economy will look towards other sectors to sustain the “healthy bull market” recently touted by state media, and the economic recovery. The services sector could be one such sector to take the baton. The Caixin services measure, which surveys 400 purchasing managers, reported its sharpest increase in activity since August 2010 in June with a reading of 58.4, while new orders rose for the first time since January. Anecdotal evidence suggests many firms see greater customer numbers and the return of demand conditions to pre-virus conditions due to lockdown measures easing. Backlogs in work also rose for the first time in four months and expectations of business conditions over the next 12-months hit a three-year high. With new export orders also rising and the service sector lagging the industrial rebound, the conditions for a rebound in the service sector look ripe for Q3 especially as economies globally loosen lockdown measures. With the service sector accounting for roughly 50% of China’s GDP, the service sector PMI is the one to watch in Q3.
The lack of a rebound in social consumption remains concerning, however. When compared to May 2019, the cumulative value of retail sales sits 13.5% year-to-date.
Even measured monthly, retail sales are yet to rebound with May’s data showing a 2.8% contraction compared to the year prior. With this release recorded prior to the localised outbreak in Beijing, we are yet to see the impact on consumer sentiment. With retail sales data undershooting expectations in May at -2.8% vs -2.3% expected and the outbreak in Beijing, downside risks prevail to the speed of the recovery in consumption.
Q2 GDP will print positive, but the message it gives markets is important
Estimates for Q2 GDP growth range from -3.1% to 3.0% YoY with the median expectation sitting at 2.5%. Excluding ING bank, all forecasts supplied to Bloomberg expect a positive GDP reading. Notably, Pantheon Economics outline that there are incentives for Chinese authorities to underreport the Q2 GDP figure to avoid sending the wrong signal. Pantheon see an official release of 1% YoY as enough to signal that authorities have stemmed the hemorrhaging of the economy in the second quarter, while being low enough to maintain expectations that further stimulus will be incoming should another substantial threat to the recovery materialise. A strong GDP figure, on the other hand, could signal that monetary and fiscal stimulus has played out given the strength of the economic recovery, while a negative figure would prompt a global market rout and pressure on USDCNY. Given the fact that the PBoC are set to wind down their support measures after the 1Y MLF was held in May and June at 3%, while total social financing is due to slow, we don’t expect the official GDP print to be revised down into negative territory for the risk of stoking expectations of further stimulus.
n.b. June’s CPI, Money Supply and Aggregate Financing data is due this week, along with June’s trade balance set to be released on the 14th. Industrial production, retail sales and the surveyed jobless rate will be released alongside GDP on the 16th at 03:00BST.
Year-to-date China’s economy is expected to be 2.4% behind 2019’s growth rate in Q2 after factoring in the 2.5% median estimate. This sets the pace of growth substantially below the post-financial crisis trend
Author: Simon Harvey, FX Market Analyst