China’s growth cycle is turning

This will mean that the worst of the regulatory tightening campaign is over. The policy change is likely to lead to a moderate recovery in China’s growth cycle this year.

Structural policies such as the pursuit of greater common prosperity and the reduction of carbon emissions are likely to be implemented much less aggressively than in 2020 and 2021.

Beijing has also reportedly already distributed 1.46 trillion RMB as a special quota of local government bonds. That’s at least 40% of the estimated total. The funds raised must be deployed in early 2022 to stimulate aggregate demand.

The People’s Bank of China (PBoC) will contribute to efforts to preserve growth with further monetary easing, especially for strategic and green development sectors that feature high on Beijing’s priority agenda.

Local governments will move towards pro-growth policies in 2022 when they have to choose between stabilizing growth and containing debt levels, the former now a political priority.

Turnaround indicators

With further easing and more special bond issuances on the cards, credit growth is expected to accelerate in early 2022. The PBoC has already twice cut banks’ reserve requirement ratios by a total of 100bp since July 2021. Along with selective rate cuts on its lending facilities, including the Medium Term Loan Facility (MLF) and the Prime Lending Rate (LPR), monetary policy has started to stabilize the lending momentum and overall credit growth.

In policy statements from December 2021, the Central Economic Work Conference made it clear that stabilizing GDP growth would be the top priority for 2022. Policymakers are channeling liquidity to priority investments in green economy development , climate control, reduction of carbon emissions, new energies, technology and high value-added manufacturing.

The sharp slowdown in the real estate sector (Figure 1) due to the tightening of policies has led to an increase in defaults, an increase in market risk aversion and an increase in the risk of credit default. The initial pace of the correction was aggressive and disruptive. However, the authorities’ firm and swift political reactions helped avert a systemic crisis, showing that Beijing has both the skills and the tools to contain any crisis.

Authorities have taken further steps to prevent credit foreclosure by urging banks to increase development lending and lifting onshore bonds and restrictions on issuance of asset-backed securities. Local governments in hard-hit cities have relaxed restrictions on developers’ access to pre-sales products, which are a crucial source of funding.

We believe that the Chinese banking system is strong enough to cope with an increase in delinquencies in the real estate and construction sectors. [1]

The International Monetary Fund has estimated that Chinese banks had an average Tier 1 capital ratio of 12% in the first quarter of 2021 (latest data available). This suggests that the system has a large cushion for potential shocks, making the risk of a real estate crash pulling the rug out from under the economy manageable. The market should have taken this into account now.

As part of renewed efforts to promote growth, Beijing should relax its ambitious targets for reducing energy intensity and consumption. This easing should ease the constraints on growth. It has already shown flexibility in lifting restrictions on coal production when energy shortages disrupted production and supply chains and hurt GDP growth at the end of 2021 (Table 2).

China has shifted its decarbonization policy to a “pre-fallback investment” framework of the previous “brute force decarbonization” approach. Now, the campaign to reduce carbon emissions will first increase investment in alternative energy sources before moving away from traditional energy sources, especially coal, to minimize energy shortages.

Major short-term risks

The two main risks to growth are weakening export growth and new mutations in the coronavirus.

The robust growth of China’s exports since mid-2020 is a direct result of its “zero Covid policy” (ZCP). This allowed Chinese production to quickly normalize to meet global demand at a time when production in the rest of the world was crippled. [2]

When production and consumption normalize in the rest of the world, Chinese export growth is likely to weaken, resulting in lower GDP growth, ceteris paribus.

Omicron and any other evolving viral strain with greater transmissibility suggest that Chinese ZCP will stay in place longer. If China is to step up its containment measures, including selective closures and border closures, the consumption and service sector (which account for over 50% of GDP) will face serious disruption.

Meanwhile, it is unclear to what extent another Covid outbreak in developed markets would boost consumption of home products from China. Such a demand may have been largely satisfied now.

[1] See ‘Chi time: China Credit Events (II) – Will the Real Estate Market Collapse? »October 22, 2021.

[2] See “Chi time: China’s Zero-Covid Policy – Timing, Benefits, Costs and Impact ”, November 24, 2021.

All opinions expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different opinions and make different investment decisions for different clients. The opinions expressed in this podcast do not constitute investment advice in any way.

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