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Struggling for momentum

China’s post-Omicron rebound has fizzled out and the prospects for near-term growth are poor. Virus outbreaks are happening with increasing frequency. The housing market remains in a downward spiral. And exports look set to drop back before long. To make matters worse, credit growth has so far been unresponsive to policy easing. More support is on its way but it will probably be too late too little to prevent output from stagnating this year. And once the economy does return to growth, it will be at a slower pace than in the past.
  • China’s post-Omicron rebound has fizzled out and the prospects for near-term growth are poor. Virus outbreaks are happening with increasing frequency. The housing market remains in a downward spiral. And exports look set to drop back before long. To make matters worse, credit growth has so far been unresponsive to policy easing. More support is on its way but it will probably be too late too little to prevent output from stagnating this year. And once the economy does return to growth, it will be at a slower pace than in the past.
  • The July activity and spending data published Monday were much weaker than expected, suggesting that China’s economic recovery from the Omicron wave slowed to a crawl last month. A preliminary reading of the China Activity Proxy, our in-house alternative to the official GDP data, also points to the rebound having stalled (See Chart 1.) And high frequency data show little improvement during the first half of August.
  • The reason for this lacklustre performance is that although the blow to activity from the Omicron wave has now dissipated, the wider cyclical and structural headwinds facing the economy have, if anything, intensified since the start of the year.
  • The presence of more infectious COVID-19 variants means that outbreaks are now occurring more widely and frequently. (See Chart 2.) Even if these are quickly quashed, the recurring disruption from containment measures needed to sustain the zero-COVID policy will continue to hold back in-person service sector activity. The alternative option – learning to live with virus as most other countries have – is seen as politically unacceptable for now given that China’s elderly population remains vulnerable. As of 22nd July, only 38% of Chinese aged 80 and above had received three doses of the domestic vaccines, which studies suggest offers similar protection as two doses of the mRNA jabs used elsewhere in the world.
  • The property sector has gone from bad to worse, with few signs of an imminent turnaround. Homebuyers across the country are refusing to repay mortgages on projects suffering construction halts. This has shaken confidence in the housing market by highlighting the risk of buying presold apartments from struggling developers. It has also encouraged banks and local governments to tighten mortgage approvals and rules on developers’ use of presale funds, exacerbating the financing squeeze facing the sector. Unless officials step in to plug the large hole on developer balance sheets the vicious circle between falling sales and rising construction halts is likely to continue. State guarantees announced on Tuesday for some developer bonds are a small step in that direction but they only apply to the strongest firms and fall short of the wider bailout needed to stabilise the sector.

Chart 1: CE China Activity Proxy & Official GDP
(2019 = 100, seas. adj.)

Chart 2: Share of Economic Activity in Areas Undergoing Local COVID Outbreaks* (%)

Sources: CEIC, Wind, Capital Economics *Outbreaks = at least 10 cases

  • China’s current economic woes would be even worse if not for the fact that exports have boomed lately – even after stripping out rapid price gains they are up over 30% since the start of the pandemic. But there are signs that demand is now dropping back sharply amid the global economic slowdown and a reversal in the pandemic-induced shift toward goods consumption. We think export volumes could fall more than 10% over the coming quarters as the current backlogs or work give way to a dearth of new orders.
  • In past downturns, officials turned to stimulus to get things back on track. Juicing the economy with more credit was usually enough to first put a floor beneath growth then drive a robust rebound. Doing so was largely just a matter of loosening the quantitative controls, such as loan quotas, that have long been the main constraint on credit growth. Cuts to policy rates and reserve requirements served as an added tailwind.
  • Despite its reluctance to embrace large-scale stimulus, the PBOC has been trying to engineer a pick-up in credit growth since the turn of the year. Quantitative controls on lending are opaque. But surveys suggest they have been meaningfully relaxed recently. Normally this would translate into a jump in bank lending but that hasn’t happened this time. (See Chart 3.) At first it was tempting to shrug this off as a temporary issue caused by lockdowns. But the disappointing July credit data leave little doubt that the problem is a lack of loan demand amid the uncertainty caused by the housing downturn and recurrent virus disruptions.
  • The PBOC responded with a surprise 10 basis point cut to its policy rates on Monday. We now expect two more 10bp cuts over the remainder of this year and continue to forecast a RRR cut next quarter. These moves will be largely symbolic, however. The PBOC wants to reassure market participants and its political bosses in Zhongnanhai that it is taking action to shore up the economy. But in practice, the central bank still appears reluctant to slash rates on the scale needed to make a meaningful difference to loan demand. The PBOC is eager to conserve conventional policy ammunition as long as possible.
  • That leaves fiscal policy as one of the few viable channels to prop up growth. The challenge is that the government has already exhausted most of the fiscal support budgeted for this year. Amending the budget isn’t out of the question but the political bar for doing so is high – the last time it was done in response to an economic slowdown was during the Asian Financial Crisis. Officials could turn to off-budget borrowing instead but that would undo much of their efforts since 2015 to tackle hidden government debt.
  • All told, we think policymakers will have to do more. But given the increasingly difficult trade-offs they face, any further support is likely to only partially offset the many near-term headwinds. We continue to think that China’s economy will stagnate this year – we anticipate 0% growth on the China Activity Proxy. The official GDP figures are unlikely to fully acknowledge this. But they will be weak too, not least because the Politburo recently downplayed the importance of meeting growth targets, reducing pressure on the statistics bureau to massage the data. We now expect official growth of 3% this year, down from 4%. Growth should rebound further ahead provided that the zero-COVID policy is relaxed – officials have hinted that this could happen next spring. A weak base for comparison will help next year too. But growth is likely to remain slow by historic standards – we think trend growth is now 1%-pt lower than pre-pandemic. (See Chart 4.)

Chart 3: Bank Lending & Loan Approval Conditions

Chart 4: CE China Activity Proxy (Q4 2019 = 100)

Sources: CEIC, Wind, Capital Economics


Julian Evans-Pritchard, Senior China Economist, julian.evans-pritchard@capitaleconomics.com

Julian Evans-Pritchard Senior China Economist
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