We continue to see policy normalization as a signal that the Chinese government and central bank are confident about the progress of economic recovery, which in turn should support the business sector.
Chief Market Strategist, Asia Pacific
The Chinese economy expanded by 18.3% year-over-year in 1Q 2021, the boost to growth flattered by the pandemic-induced collapse in economic activity from a year ago. On the other hand, the quarter-over-quarter GDP growth rate was 0.6%, as the base effect has faded since the peak in 3Q 2020. We view the sequential quarterly growth rate as a better reflection of economic momentum and how far economic activities have normalized. Sector value-add data showed that the growth was more balanced in comparison to previous quarters, as activities in service sectors continue to improve.
Industrial production and fixed asset investment in March were also boosted by low base effect from a year ago. However, again here the momentum is slowing and implies a normalizing growth path in the months ahead. The focus should be on consumption data, which kept improving in March in comparison with the previous month, after some limitations on domestic travels during the Lunar New Year holidays. We expect consumption to act as a growth stabilizer for the rest of this year. In contrast, infrastructure investment may be less of a contributor to this year’s growth during the course of policy normalization.
China’s exports and imports momentum remains robust. Given the partial lockdown measures adopted in 1Q 2021, Chinese manufacturers were working at high capacity during the Lunar New Year holidays to meet the demand from global consumers and enterprises. As a result, counter-cyclically high growth rates were reported in Chinese industrial production and export value. It is noteworthy that a stronger trend was observed in imports, driven by the rising prices of oil, metals and semiconductor chips. This may create some near-term inflation pressures in the economy.
Looking forward, the trend towards more “normal” rates of growth will likely continue for the rest of the year, with domestic consumption expected to be the major driver. Further support from the global recovery is also expected, especially as the vaccination progress remains slow in many emerging market economies.
EXHIBIT 1: CHINESE CREDIT IMPULSE AND GLOBAL NEW ORDER
In terms of policy response, the central bank and fiscal authorities are returning to a more neutral stance, although some selective measures might be continued to support the small and medium-sized enterprises. After the strong credit expansion in 1Q 2020, domestic liquidity conditions are likely to become more balanced, and regulators might make further efforts to cool down the property market and control domestic leverage. Fiscal discipline might also be strengthened, leading to deceleration in local government financing and infrastructure investment.
We continue to see policy normalization as a signal that the Chinese government and central bank are confident about the progress of economic recovery, which in turn should support the business sector. Alongside the positive momentum in economic growth data, many Chinese companies are also reporting very strong earnings growth in 1Q 2021. However, the lackluster performance of the A-share market suggests that investors are taking a forward-looking approach, expecting corporate earnings to return to their normal levels after the recent spike. Moreover, the prospect for a subdued stimulus may put a cap on further valuation upside in the equity market. Under such circumstances, it is important for investors to focus on quality and long-term growth potential. As China’s economic growth stays on track, we remain constructive on sector leaders in technology, consumption and financial services.
Over the longer investment horizon, the National People’s Congress in March clarified the path for structural changes in the Chinese economy during the 14th Five-Year Plan (2021 to 2025). The key themes for investors to follow include carbon neutralization and self-sufficiency in key technologies supported by the Chinese government. Some key domestic players might benefit from China’s huge market scale and policy support and grow at a faster pace in 2021 and beyond.
There are also concerns that monetary normalization could tighten liquidity condition and lead to a rise in default risk, both for property developers and state-owned companies and financial institutions. For developers, the stronger players have maintained a strong balance sheet and adjusted their land reserve in expectation of property price-cooling measures. For the broader corporate bond market, Chinese regulators have in recent years tolerated defaults, including state-owned enterprises, to allow credit risks to be properly priced. However, we expect government support would kick in if defaults increase the systemic risks in the Chinese financial system.