Manu Bhaskaran: The Chinese economy could give us all a big lift
China’s economy now accounts for about 16% of the world’s output, up from around 9% a decade ago. So, what happens there matters hugely for the rest of us. If China pulls off an upside surprise to growth — as we believe it will — the rest of the world will enjoy stronger export growth, higher commodity prices, improved business confidence and brisker risk appetites for financial investors. Emerging currencies might also strengthen. The principal beneficiaries will be Asian economies.
In our view, the second half of the year will bring a vigorous upturn in the Chinese economy, powered by even more policy stimulus. Chinese leaders have strong political reasons to pull out the stops to ensure high economic growth this year and next. Yes, it is true that they have signalled that they will not repeat the “flood-like” stimulus efforts in 2008–2009 which they now feel was excessive and created imbalances that they had to struggle with for years. But, even as they will carefully calibrate their measures, the net effect will be a substantial easing of credit policies. They will complement this with a range of other measures that will bring economic growth back to above 6% in 2021.
There are several political reasons why China’s leaders will want an impressively strong economy in the next year or so. First, Communist parties love anniversaries and the Chinese Communist Party (CCP) is no exception. In July next year, the CCP will mark the 100th anniversary of its founding. Apart from ending a hundred years of humiliation by foreign powers when it took over, the CCP’s claim to legitimacy is that it has delivered an unimaginably rapid transformation of the economic lives of ordinary Chinese. Since moving away from its ideological roots, vibrant growth and economic security underpin its claim to be legitimate rulers of China. Thus, to pull off a successful celebration, President Xi Jinping and his colleagues must be able to show off a humming economy that is carrying the Chinese people to ever greater heights of economic well-being.
Second, and related to this, is the goal that the CCP set for itself, which is to double the size of China’s economy in the decade to 2020. The contraction in economic growth in the first quarter makes that goal almost impossible to achieve but Xi would want to have that in the bag by July 2021. The CCP had also promised that by the end of this year, it would have brought China to the level of a “moderately prosperous society”. Without a strong spurt of growth in the second half, analysts believe that China would not be able to deliver on some of the specific targets embedded in this promise.
Third, the Chinese leaders know that they are now in a tussle for global influence with the US and its allies. It would serve their geo-political interests well to demonstrate to the world how superior the Chinese system is to the US and the other Western countries. How better to show that than to pull off a miraculous economic recovery just as their rivals are floundering?
Finally, the Chinese leaders are only too aware that the rebound so far has been partial and still somewhat fragile. In particular, there is a risk that a lot of folks who lost their jobs may not be easily re-employed unless consumer demand comes back faster than it is. There are also a huge number of fresh graduates who are struggling to find a job. A weak jobs market could pose not just an embarrassment but possibly a political threat. Note that while production data such as industrial production has recovered nicely, the data does not show an equivalent bounce back in demand. A considerable gap has opened up between industrial production growth, which is now back to a normal range of about 4–6% and retail sales which still fell 2.8% in May. Another indicator of demand — fixed asset investment shrank by 6.3% in May. Policy makers know that they must juice up growth by a bit more to ensure that demand gets back on track.
The latest meeting of the State Council (China’s cabinet) suggested that policy makers plan to strengthen the credit impulse. Banks have been instructed to give up RMB1.5 trillion ($295.3 billion) or about 75% of their retained earnings this year and pass them on in the form of cheaper borrowing costs to the real economy. China’s central bank also announced that it would cut the reserve requirement ratio so as to release more liquidity into the banking system. It also hinted that it wanted a lot more lending to flow to small businesses.
Another tool Chinese leaders will use to boost the economy is to ease up on restrictions placed on the real estate sector, which would then become a stronger driver of domestic demand in the second half of this year. Chinese Premier Li Keqiang, in delivering this year’s Government Work Report, repeated the mantra “houses are for living in, not for speculation”, but he omitted a crucial reference to stabilising property prices and market expectations which the Central Economic Work Conference had emphasised last December. That suggested that China’s leaders feel it is appropriate now to unleash the real estate market. In recent months, policymakers have subtly allowed provincial and city governments more leeway to fine-tune their housing policies. Real estate has multiple spillovers to upstream sectors such as materials like steel and downstream sectors such as financial services. As home prices start to rise again, the wealth effect will turn positive and support consumer spending as well.
What is also encouraging is that China is using supply–side reforms to power up growth as well. After years of hesitation, they have started to move more energetically on liberalising the
laws (or household registration system), which restrict the rights of migrant workers in urban areas. By empowering these workers, China will see an underclass of around 280 million secure higher wages and be allowed to buy property in the smaller cities. reform itself could thus end up being a driver of growth. China’s leaders are also planning a big surge in spending on research and development in order to reduce reliance on an increasingly hostile America for technology. They are also implementing interesting initiatives on “new urbanisation” that would create gigantic urban clusters and “new infrastructure” comprising data centres, 5G networks and base stations, logistics infrastructure and ultra-high voltage electricity grids that will help expand the use of renewable energy.
The policy makers’ efforts are yielding good results. Our estimate of the credit impulse now clearly exceeds anything seen in the past ten years. The growth in the outstanding stock of credit, as measured by aggregate social financing (a broad gauge of Chinese credit flows), accelerated to +12.5% y-o-y in May — the quickest pace in two years — supported by robust bank lending, local government bond issuance and corporate bond issuance. The data also shows that the most-credit starved parts of the economy – the micro and small-sized enterprises – are gaining access to more loans. When these enterprises get cash, they tend to spend – hiring more workers and buying inputs, and so boosting the economy.
The credit impulse is a reliable lead indicator for the overall economy, its trend bodes well for a strong uptick in economic activity in the second half of the year. Some forward-looking indicators suggest that the real estate sector is poised to boost economic growth. New home starts which presage residential fixed asset investment expanded for the first time this year while developers’ land purchases continued to rise in May, reaching their highest level this year. That indicates that some of the policy-driven increase in liquidity is finding its way into the property market.
Moreover, home prices rose at the fastest pace in seven months in May, with new home prices in the 70 major cities up 0.49% and existing home prices rising 0.24%. The rebound was strongest in the four megacities including Beijing and Shanghai, but the pattern of price increases were broad-based across first, second and third-tier cities.
There is also a growing likelihood that investment will revive. The survey of purchasing managers shows the construction sector rebounding very strongly. Moreover, the strong trend in sales of excavators recently also reflects that the construction sector is already reviving. We envisage infrastructure investment which accounts for roughly 30% of the total to grow in the high single-digit range by the end of 2020.
We see a successful expansion of policy support resulting in the economy growing by at least 2-2.5% this year, higher than the World Bank’s estimate of 1% and then surging by more than 6% in 2021. Such a recovery will provide a good boost to the global economy and Asia.
First, Chinese imports account for about 10% of total world trade, so the demand for energy, primary commodities, intermediate goods and finished consumer and capital goods will grow. As Asian economies export a lot of commodities and intermediate goods to China, their exports will rise. Second, China remains the single largest importer of raw materials. Its recovery will bolster the prices of oil, thermal coal, coking coal and base metals. That will help primary commodity exporters.
Third, a stronger Chinese economy will help improve business confidence while reducing one source of anxiety for companies — if at least the second largest economy in the world is on a solid trajectory, things might not be so bad. Fourth, a vibrant Chinese economy should improve the risk appetites of global investors and raise their interest in investing in emerging market assets.
Fifth, as China’s economy regains traction, its companies are likely to resume outward investment. Since geo-political tensions make it more difficult to invest in developed economies, they will probably look at emerging economies, especially those which are close neighbours. Finally, once the Chinese economy is on a sound footing, the Chinese government will feel more confident in reviving its ambitious Belt and Road Initiative — which envisions linking China to Europe, Africa and Asia through a network of ports, railways and roads — is channelling large amounts of Chinese capital into building infrastructure in developing countries, mostly in Asia.
In short, there is good reason to believe that China will pull off a better than expected economic recovery and that its Asian neighbours will be the principal beneficiaries. E
Manu Bhaskaran is CEO at Centennial Asia Advisors