In this blog, we highlight the recent developments to China's macro and policy arrangement.

We’ve upgraded our 2024 full year GDP forecast on stronger first quarter GDP and capped housing downside risk on recent policy moves - as China remains in a rebalancing mode. In this blog, we highlight some recent developments and provide our view on the investment implications.

Manufacturing and exports – Structural changes to accommodate quality growth and geopolitical tension

Discouraging new investment in three new sectors. Three new sectors (EV, lithium batteries, and solar panels) have been catching most of the attention amid repeated news headlines and discussions on overcapacity issues. With rising external tariff risk and the persistent domestic auto price war, top authorities (including Xi Jinping) have been persuading potential producers not to enter the market and to try other areas instead. We saw new guidance on curbing investment in lithium batteries and pushing M&A in solar panel sectors. Though we see limited impact on China’s GDP due to the EU tariff on Chinese EV exports, we think policy makers are moving in the right direction given record low profit margins in the auto sector and corresponding supply side reform is necessary.

Tailored programs for emerging industries and traditional sectors. China set up the third semiconductor fund recently with a registered capital of CNY344bn and the total capital input reaching ~CNY700bn (including the first and second funds). The previous two funds financed a lot of the leading local producers, covering chip design, fabrication, assembly and tests. The third fund signals strong policy tendency and persistent efforts to strengthen the weak links. In traditional sectors, authorities have been continuously pushing manufacturing equipment upgrades since the beginning of the year, targeting on efficiency improvements and green development. According to the National Development and Reform Commission (NDRC), manufacturing equipment upgrade FAI (Fixed Asset Investment) contributes more than 50% of the FAI growth so far this year. We expect green FAI will add to already high manufacturing FAI growth for the rest of the year.

Export diversion from DM to EM. We observed less DM (developed economies) drag on China’s export growth in the first five months of this year. At the same time, we saw higher contribution from EM (emerging economies), such as Vietnam, Mexico and Saudi Arabia. Firstly, DM restocking and tech cycle recovery support resilient DM demand. Secondly, China offshoring is accelerating amid increasing US reshoring, reflected in increased intermediate good exports from China to other manufacturing specialized EM. Lastly, China has been pushing final goods export diversion from DM to Belt and Road countries on heightened geopolitical tensions. While the first driver is more likely to be cyclical, we see the other two drivers as structural and expect such trends will persist for years.

Consumption – Continued to favor tourism and incremental support from goods trade-in

Tourism remained the top pick among various household expenditure surveys, and we see persistently strong tourism visits during each local holiday season; this is reflected in continuously higher services consumption growth than growth in goods since last year. However, in terms of expenditure per visit, we note it is still below pre-COVID levels, implying some degree of consumption downgrade. In particular, we see that locals favor shorter trips and tourism in lower tier cities with lower costs, compared to pre-COVID. Take recent Labor Day holiday data as an example, tourism visits are already 17% higher than pre-COVID levels while expenditures per visit remain 12% below.

Visible policy impacts from goods trade-in program. We note a visible pick-up in home appliance and communication device retail sales backed by the goods trade-in program supported by policy. Overall, home appliance retail sales increased by 7% YTD yoy (Jan-May 2023: -0.2% yoy) and communication device retail sales increased by 13.9% YTD yoy (Jan-May 2023: 3.3% yoy). In particular, home appliance sales under the trade-in program increased by more than 80% yoy during Jan-May; this is in stark contrast to sluggish home sales. Meanwhile, domestic EV sales also increased by 32.5% yoy in Jan-May on trade-in support.

Housing – Green shoots instead of overall positiveness

Housing inventory reduction is back. For the first time in 8 years, policy makers put reducing housing inventory back on their policy agenda. Compared to 8 years ago, when the CNY3.7trn Pledged Supplementary Lending (PSL) backed shanty-town program began, the recently announced CNY300bn People’s Bank of China (PBoC) relending is much smaller in size. But, compared to the strong policy determination on housing crackdowns during 2021-2022, we read the move on the positive side as policy makers are stepping into housing rebalancing by leveraging (quasi) fiscal support.

Still a ways to go. According to our estimate, based on the past 12 months of average monthly home sales volume, the housing inventory absorption period remained 6-9 months higher than the normal level (~18 months) on average. As the policy impact on boosting up household housing demand seems to be diminishing compared to last year, we expect policy makers to scale up support on government direct purchase of housing inventory in the second half of this year (H2).

Monetary policy – Accommodative while not aggressive

Both average loan rates and mortgage rates remain on a downward trend, and we expect this trend to continue in H2. Meanwhile, deposit rate cuts and the removal of high yielding special deposit products pushed more household savings from banks to wealth management products and mutual funds, keeping financial conditions (FCI) loose. We revised down Total Social Financing (TSF) growth to ~9% from ~9.5% on the PBoC changing the statistical measure of the financial sector’s contribution to GDP, guiding banks to focus more on profitability rather than credit growth. We think both a policy rate cut and a Reserve Requirement Ratio (RRR) cut remain on the table, but likely to be data dependent.