How China will recover even while developed markets flounder

ON JUL 27, the US Federal Reserve made clear its intent to rein in runaway inflation by hiking its benchmark interest rate by a further three-quarters of a percentage point.

While this hike was largely in line with market expectations, it still stoked fear of a looming US recession as it would exacerbate capital outflows in emerging markets. The impact of the hike will, however, be moderate on China, which is recovering from the fallout of the Covid-19 pandemic.

China’s cyclical growth and macro policy trajectories look increasingly divergent from developed markets (DM). Such divergence is likely to narrow the current growth differential between these 2 economic blocs, with implications on company earnings and interest rate differentials.

China is well on the path to recovery from the shock of its stringent pandemic lockdowns this year. Despite recent flare-ups of the coronavirus in some regions, its Covid-19 caseloads have tapered off since their peak in April. China’s government has fine-tuned its pandemic control strategies, including streamlining its testing, tracking and quarantine measures, and urging citizens to vaccinate. All this is towards being more efficient in guarding against Covid-19, which would do much to boost economic recovery. There is a delicate balancing between aiming for zero Covid cases and reopening for business. For starters, China is reducing the hassle for visitors by shortening the quarantine periods for foreign travellers.

Meanwhile, recent data shows that China’s economy is emerging from its trough in early 2022 and gaining momentum. Domestic demand is starting to recover from a very low base. Although Q2 2022 gross domestic product (GDP) growth was disappointing, June macro data such as industrial production, retail sales and fixed asset investment growth all accelerated from the prior month.

Assuming China continues to contain Covid-19 in the second half of 2022, private sector demand should recover further over the coming quarters, stoked by the government’s tax relief measures and stabilisation of the country’s property market. The State Council launched 33 measures to stimulate economic activities, which included VAT cuts and tax rebates for vehicle purchases.

On the rebound

These measures will likely ease the economic strain on small and medium-sized enterprises (SMEs) and their customers. Meanwhile, property sales recorded sequential improvement in June, suggesting that the measures launched by the local governments to lift the property sector are working. Private sector demand, however, is unlikely to rebound significantly in H2 2022, due largely to China’s still-tight Covid-19 controls and a slowing global economy. The country’s stabilisation measures will, however, do much to drive public sector demand towards a rebound in H2.

Such public sector demand is being bolstered by China’s aggressive push for infrastructural investments and the proactive provision of funding. Also, we believe its government will provide relentless support to boost growth. For example, besides front-loading the 3.65 trillion yuan (S$742.3 billion) 2022 Local Government Special Bond (LGSB) issuance quota to H1 2022, the State Council has also leveraged on the policy banks by granting 800 billion yuan’s worth of new internal credit lines and another 300 billion yuan in seed equity funds for infrastructural projects through the China Development Bank and the Agricultural Development Bank of China.

Gloom in developed markets

Meanwhile, the DM economies are likely to experience a slowdown in cyclical growth in the coming quarters, with the latest macro data showing the US economy lagging faster than anticipated. Both the Dallas Federal Reserve and Richmond Federal Reserve Manufacturing Activity Indices disappointed on the downside, falling 17.7 (consensus: -6.5) and 11 points (consensus: -7), respectively.

The Conference Board Consumer Confidence Index sank sharply to 98.7 in June (consensus: 100) from 106.4 in May. The June Institute for Supply Management (ISM) Manufacturing Survey also softened to 53 (consensus: 54.5) from 56.1 in May, dragged down by the disappointing purchasing managers’ index (PMI) new order which turned contractionary at 49.2.

The latest PMI surveys and consumer confidence indices for the EU have also been trending down, while the Russian-Ukraine conflict has deflated business confidence and sent energy prices soaring.

The US economy is in a better position than the EU, thanks to the hefty stimulus cheques and aggressive US monetary stimulus rolled out during the pandemic. The Congressional Budget Office recorded the aggregate sum of Covid-19 relief packages disbursed in the US during the pandemic as likely reaching US$5.1 trillion, or 24.5 per cent of US GDP. In comparison, the magnitude of Covid-19 relief provided by the EU is estimated to be less than half of the US outlay.

The extent of the Fed’s monetary easing was also much greater than the European Central Bank (ECB)’s during the pandemic. We think this disparity in pandemic stimuli explains the differences in demand-pull inflationary pressures and the growth cushions each has.

Divergent macroeconomic phases

On the policy front, China and the DM are in opposing phases. China is in easing mode to boost growth, while the US and EU are tightening fiscal and monetary conditions to fight inflation.

China can be proactive in stimulating growth because it is not experiencing spiralling inflation. The Chinese economy rebounded swiftly after H1, thanks to the success of its Covid-19 controls and a surge in external demand. China thus narrowed its augmented fiscal deficit in 2021 to 8.8 per cent of GDP in 2021 , from 15.4 per cent in 2020.

The Chinese government is also expected to further ease its regulatory controls over the pandemic, the property market and Internet companies to support growth. Recent measures include a 15 basis point cut in 5-year Loan Prime Rate on May 20, 2022 and moves by local governments to buoy the property sector, such as nullifying purchase restrictions. China’s grip on Internet companies has also been relaxed, save for the recent fines imposed on a few major players for past violations. Pandemic-related regulations should be streamlined further, although the recent flare-ups in new Covid-19 infections have triggered fresh market concerns.

The US and EU, however, have their hands tied due to rising inflationary pressures which are forcing them to pursue austerity measures to rein in domestic demand. Despite market concerns about a coming recession, both the Fed and ECB remain vigilant on inflation and have pledged to normalise monetary conditions to contain it. We do not expect either central bank to pivot and turn dovish in the near term as suppressing demand seems unavoidable to stabilise prices.

The writer is senior economist, Asia-Pacific at Allianz Global Investors.