China: Awaiting clearer policy signals
- The latest resurgence and the implementation of strict lockdowns point to the Chinese government’s determination in pursuing the zero-COVID-19 strategy.
- This implies potentially a more volatile growth outlook for China as curbing social activities may act as the shock absorber to prevent any resurgence in infections.
- Regulatory reforms also remain in the cards for some of the “new economy” industries where the Chinese authorities see the need to achieve better social outcomes.
- We remain cautious on the earnings growth of these sectors until there are clearer signals of a more stable regulatory regime.
- The left chart demonstrates the progress of COVID-19 vaccinations across the world, illustrating the percentage of populations that have received at least one dose of vaccine. Many economies have accelerated their vaccination rollouts compared to August, helping to control the virus transmission and allowing for slow resumption of economic activity.
- China is among the economies with a high vaccination rate. In addition, social distancing measures, border controls and lockdown measures have been maintained, thus keeping new case numbers low.
Effective control of the pandemic comes at a cost
A relatively high vaccination rate combined with stringent control measures aimed at achieving zero-COVID-19, has kept reported domestic infection cases at a low level. However, this might imply higher economic and social costs than the other economies.
- China has accelerated its vaccine distribution program since 2Q 2021. 76% of the population have received at least one dose of vaccine. China also began vaccinating children in 3Q 2021.
- To suppress the virus, social distancing measures have been maintained even as infection rates stayed low. Partial lockdowns and large-scale virus screening are launched whenever new cases are discovered. These measures are aimed at curbing widespread transmissions.
- However, the current strategy comes at a high cost to the government, as well as unexpected disruption to economic activity.
- Policymakers aim to boost China’s long-term growth potential and achieve better social outcomes through a series of regulatory campaigns.
- Property, internet and education are the major sectors subject to pressures. Policy uncertainties will likely persist until there are clearer signals of a shift to a more stable regulatory regime.
Short-term headwinds from escalating regulation
With gradual recovery from COVID-19, Chinese policymakers are introducing various schemes to address the challenges of long-term growth.
- To curb the downward trend in the birth rate, property market controls have been ramped up to lower housing cost and off-school tutoring services have been restricted to relieve the education burden on families.
- Internet-related sectors are under continuous pressure from anti-trust investigations, which are deemed as a necessity to improve competition and support small and medium-sized enterprises.
- These measures are necessary to achieve sustainable growth in the long run. However, short-term uncertainties are rising, particularly in terms of consumption and private investment.
- Credit impulse on the left measures the year-over-year change in the credit flow within China. The chart shows that China started policy normalization in mid-2020 when the economy was recovering from the COVID-19 pandemic. Credit conditions continue to tighten in 2021, thereby affecting China’s external demand in the global market.
- The right chart shows the issuance of bonds relative to the annual quota. 2021’s issuance is running below prior years, implying Chinese official have room to increase fiscal spend to support growth if needed.
Structural fine-tuning expected
When policymakers adhere to their long-term reform plans, the fine-tuning of monetary and fiscal policies is also necessary to offset the shocks so as to smoothen the short-term growth trajectory.
- The PBoC announced a 50-basis-point reserve requirement ratio (RRR) cut on July 9, 2021, which released about RMB 1trillion long-term funds to replace the outstanding medium-term lending facility (MLF). One or two more such measures could occur before the end of 2021, alongside structural interest rate cuts to support small businesses.
- In addition, fiscal policy may do more of the heavy lifting to support growth, especially as the 2021 government bond issuance is running below this year’s quota and could be stepped up.
- These operations may help improve liquidity conditions and provide some tailwind to the manufacturing sector.
- Given the economic cost and difficulty in eradicating COVID-19 within the community, especially as more Asian governments start to reopen their economies, we believe Chinese policymakers may also evaluate their zero-COVID-19 strategy in the near term.
- The loss of momentum in the economic recovery simply strengthens policymakers’ case to act in a timely manner to stabilise growth. Fiscal policy will likely take the lead as monetary easing may remain targeted.
- This should help buffer some of the short-term reform shocks. A marginal improvement in liquidity conditions for the rest of this year would be a policy tailwind for the manufacturing sector. Meanwhile, after a prolonged correction, the consumer sector could also benefit from policy easing and more resilient sentiment.
- We still believe China remains an integral part of any investor’s portfolio, both in equities and fixed income. However, flexibility and selectivity are crucial.