Normalizing growth and fine-tuning policy
China’s year-over-year (y/y) GDP growth rate declined to 7.9% in 2Q 2021. Although this marked a significant slowdown from the peak expansion of 18.3% in 1Q 2021, the y/y growth rate was always going to be heavily skewed by the COVID-19 slump in the first quarter of 2020.
Per our estimate, the annualized quarter-over-quarter GDP growth rate was moderate at around 5.3%. Compared to the same period in 2019, the average growth rate in the past two years was 5.5%, suggesting China’s economic growth has already peaked and is easing back to its long-term average growth rate.
Major monthly economic indicators are also pointing to normalizing but still resilient domestic demand in June, particularly in consumption. Despite the drag from slower growth in passenger vehicle sales (June: 4.5% vs. May: 6.3%), retail sales grew by 12.1% y/y in June (May: 12.4%), stronger than the market expectation of 10.8%. Meanwhile, driven by strong private investment (1H2021: 15.4% y/y), aggregate fixed asset investment increased by 8.3% y/y in the first half of this year, also beating market expectations.
Meanwhile, China’s export and import activity remained resilient in June. Despite recent congestions in container ports, China’s exports rose by 32.2% y/y in June, far beyond market expectations. Rebounding developed market demand coupled with the delay in Southeast Asia export recovery are driving this growth. Meanwhile, imports jumped by 36.7% y/y, boosted by rising raw material prices.
Overall, China’s economy looks to be on track for recovery, with the 2021 official 6% annual growth target within reach. However, the downside and structural risks in domestic demand deserve some attention. Long-term credit growth has remained weak as the government deployed policies to control leverage and cool the property market. The uncertainties in market regulation related to technology may also be weighing down short-term consumer and investor sentiment. Nevertheless, resilient external demand could help offset some domestic pressure and support aggregate growth, even if export growth revert to a more normal growth rate later in the year.
EXHIBIT 1: CHINA ECONOMIC ACTIVITIES
In terms of policy response, the People’s Bank of China (PBoC) announced a 50bps required reserve ratio (RRR) cut last week as a fine-tuning measure. This could help release RMB 1trillion of funds for bank lending, and lower banks’ funding costs by RMB 13billion per year. However, RMB 1trillion is still far less than the RMB 4.15trillion of medium-term lending facility maturing in 2H 2021, suggesting the RRR cut was a structural measure to stimulate long-term lending to small- and medium-sized enterprises, rather than a sharp change in Chinese monetary policy. China Premier Li Keqiang reiterated this week that the government will not flood the economy with excessive liquidity, and the PBoC also emphasized that the RRR cut is simply part of normalizing the policy environment, reflecting policy makers’ intention to manage market expectations for strong stimulus.
As GDP growth normalizes, corporate earnings growth momentum should slow down. Investors may remain cautious as uncertainties about monetary policy and technology regulation persist, likely putting pressure on stock valuations in the second half of the year. This might eventually attract some bargain hunting. Meanwhile, it will be important for investors to focus on quality companies with long-term growth potential. Over the longer-term investment horizon, interesting investment themes include carbon neutralization and self-sufficiency in key technologies, although investors need to remain selective in terms of seeking attractive entry points, as prices have already risen in these sectors.