China’s growth outlook remains weak despite better-than-expected June data

• Status of China’s Economic Recovery – China’s GDP growth slowed sharply in Q2, expanding by a mere 0.4 percent y-o-y, down from 4.8 percent in Q1. This was driven by the series of stringent lockdowns that were imposed across the country through April and May, and which severely disrupted the economic activity in China’s major cities – chief among them, Shanghai. The relaxation of control measures at the end of May led to a rapid rebound of key economic indicators in June. But July has seen a rise in new COVID cases which, together with the downcycle of the property sector and slowing global growth, means that China’s economic recovery in 2H will face significant challenges.

• Investment Trends –  Investment continued to recover in June but in an increasingly divergent manner. The manufacturing and infrastructure sectors experienced robust investment growth on the back of strong policy support, while investment in the real estate sector contracted further despite the relaxation of property restrictions. Despite our expectations for increased policy support from the Chinese government, we believe this trend will carry forward into the second half of 2022. Continued confidence weakness from prospective home buyers, a weak outlook for property prices, and liquidity constraints amongst developers will all drag down property investment growth. 

• Consumption Trends – Retail sales in June rebounded strongly from May thanks to a relaxation of COVID restrictions and the release of pent-up demand. Despite this, consumer sentiment remains weak due to slower income growth and bleak prospects in the labor market. Over the short-term, the continued recovery in consumption will be dependent on: (i) the strength of stimulus measures by the government; and (ii) the COVID situation, as restrictions will continue being tightened and reimposed to face new outbreaks, especially if caused by more aggressive variants of the virus. Inflation in China will likely remain moderate in 2H, with consumer prices rising slowly and producer prices easing. 

• Trade Trends – China’s export growth, measured in nominal value, stayed robust during 1H, but the volume growth has already moderated. High inflation, rising borrowing costs, and a looming global recession will inevitably curb consumer spending and business investment in advanced economies, which lead us to anticipate a more rapid deceleration of China’s export growth over 2H.

Implications for Business

The outlook remains uncertain. Despite improvement in the performance of some economic indicators in June, there are indications of mounting headwinds in 2022 2H. 

Domestically, a rising number of disgruntled homebuyers are refusing to pay their mortgages for unfinished projects; and it appears that this is escalating. It has been recently reported that several suppliers of materials to property developers have ceased their bank loan payments. This is exacerbating the current downturn in China’s property sector, which is estimated to contribute 14-25 percent of the country’s GDP growth. In addition, uncertainty remains regarding the potential of further COVID disruption given the continued mutation of the virus, and what this means for China’s ‘dynamic Zero-Covid’ approach. 

Externally, the global growth outlook is becoming bleaker. To fight rampant inflation, an increasing number of central banks are raising rates, with the European Central Bank being the latest in joining the list. But, as alluded to in our previous issue, this will make it more expensive for developing economies to repay the debt they acquired to respond to the impact of the pandemic, and to acquire more debt to finance more stimulus. This will add downward pressures on external demand for Chinese exports. Meanwhile, the geopolitical landscape continues to deteriorate. 

We therefore believe it will be extremely difficult for China to achieve its 2022 growth target of ‘around 5.5 percent,’ and instead forecast that GDP will grow 4 percent this year. But not only that. Chinese authorities have been escalating stimulus measures to support growth. The longer these measures remain and are escalated, the less policy room authorities will have to counter future shocks, the likelihood of which is not low given the continued impact of the pandemic and rising global risk events like climate change. This is something the Chinese government understands, which is why, in addition to the stimulus measures, over the past weeks it has also relaxed its approach to fight Covid to stimulate consumption and investment. Data already show that this is having a positive effect. But without a complete rethinking of this strategy which includes shifting to a ‘learning to live with Covid’ approach, market uncertainty will continue weakening confidence levels.