The Backdrop

China’s peak activity season is coinciding with the Western manufacturing upcycle that is now lifting global industrial production back into expansion territory. However, even as producers try to meet strong consumer demand for goods, they are faced with global supply chain log-jams affected by COVID-19 outbreaks, component and container shortages, logistical issues at ports and shipping routes as well as rising raw material input costs.

On the geopolitical front, bipartisan efforts within the Biden administration are trying to formulate a coherent policy agenda with transatlantic powers (Quad, NATO, Europe) against China on a broad range of issues ranging from South China Sea, Taiwan, Hong Kong and Xinjiang’s human rights issues, climate change, intellectual property protection, industrial subsidies and forced technology transfers. Possible US joint technological export controls with allies especially Japan may be enlisted to further thwart China’s advancements.

Looking ahead, China will both benefit from and compete with the Biden administration’s strategic infrastructure plan that will entail to secure strategic resources and technology, as well as firms’ upcoming capex recovery that will see further gains to global end-market demand through expanded infrastructure and technological investments.

China’s Trajectory and Advancement Strategy

With China’s economy slated to cruise at about 8.8% YoY growth rate in 2021, there is less need for the authorities to utilize strong countercyclical monetary and fiscal measures that it had enacted during the pandemic outbreak, thanks to a normalization of China’s services sector and stronger consumption, alongside the already buoyant manufacturing which is improving companies’ profits and cash flows.

Amidst the global upswing and with expectations of more hostilities after developed markets exit their pandemic outbreak with faster vaccine rollouts, China remains steadfast and focused on accumulating ground against strategic hegemony by the US and its allies.

Indeed, China has been keeping busy with enacting its 14th Five Year Plan, which is a series of social and economic development initiatives issued by the Communist Party of China for 2021-2025, as well as President Xi’s two-stage development plan to ensure “socialist modernization is basically realized”, double GDP or income per capita to reach the level of “moderately developed” economies by 2035 (≥ ~4.7% growth during 2021-35) and to become a global leader in innovation by 2035.

Key to China’s strategic planning involves state-administered directives to secure energy, food, technological self-sufficiency and the concept of military-civil infusion especially in the “battle for core technologies” as well as heavy investments in R&D, education, military and advancement strategies.

Opportune Time for another Clean-up Exercise

In the near term, the current global upswing poses the most opportune time for China to ensure its own house is in order as it conducts a broader restructuring to make the local economy more sustainable, less risky and speculative, as well as to improve effectiveness of capital allocation. In particular, authorities want to improve corporate governance, sustainability of business models and more importantly, reduce systemic risk and align entities to contribute to the real economy and national agenda.

Accordingly, China is shifting its looser monetary policy stance that was set during the pandemic towards a policy stance that prevents cost increases for corporates as well as more effective tightening and financial risk control. China’s goal is to stabilize its macro leverage ratio and to control risks through tighter macro prudential rules particularly for highly leveraged property firms, local governments, local state-owned enterprises or local government financing vehicles which may pose contingent liability risks to the sovereign. Targeted deleveraging and regulatory tightening could cause some defaults on the corporate side but will not likely lead to triggering systemic risk. People’s Bank of China (PBOC) will keep an accommodative monetary policy stance for the real economy with credit growth "basically in line with nominal GDP growth" with preferred areas of credit support for infrastructure, manufacturing, high tech, innovation, green development and SME support.

Outlook for China Rates

Given the backdrop of global and macro trajectory, we expect China’s broad monetary policy is expected to remain neutral. We expect PBOC to use Open market operations (OMOs), medium-term lending facility (MLF) and other tools to regulate liquidity stability (esp. during periods of large tax payments and rise in primary supply), while monitoring that short-dated money market (MM) rates revolve around the 7-day reverse repo rate within a reasonable range. No policy rate hikes (OMO, MLF) are expected this year as GDP growth moderates from Q1 high, CPI remains well-controlled (sufficient hog supply, manageable PPI pass-through) and the government pledges to keep financing costs stable for key sectors while major GCBs have stated they will maintain their highly accommodative monetary stance. We expect the authorities to tap other policy tools instead of policy rates even as the Fed ends its QE tapering and starts its cycle of rate hikes.

Material ID: 09tk211307175656