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Awaiting the year of the Rabbit: China and its policy responses to ensure a recovery in the second half of the year

By Andranik Safaryan

A lot has happened in China since the beginning of the Covid crisis. Chinese equity markets reached their peak in February 2021 after rallying by more than 40% since 2020 on the back of a successful management of the pandemic. After that, investors got caught in the crossfire of the regulatory crackdown on sectors like technology, private tutoring and property, and now equity markets erased almost all the previous gains. What fiscal and monetary instruments is the government now taking to stimulate the economy?

 “Common Prosperity”, a concept first contemplated by former president and founder of the People’s Republic of China Mao Zedong and then used by the current President Xi Jinping in 2021, is the justification for far-reaching regulatory measures. Under “Common Prosperity”, the State aims at reducing inequality in society through stronger interventions in the private sector. While the crackdown on the technology sector seems to have recently softened with a final decision taken on Didi’s case (USD 1.2bn fine), the State-induced deleveraging of the property sector has had deeper negative implications for the economy and is still causing headaches to the policymakers. As if this were not enough, the country is still struggling to contain the pandemic after an explosion of cases of the Omicron variant back in March led to the lockdown of strategic cities such as Shanghai. We take a look at the most important key questions for upcoming quarters.

How have policymakers responded to the pandemic-related slowdown in growth?

The Chinese authorities have responded in a major way and are expected to do more. As the country was locking down in March-May, both monetary and fiscal authorities have been responding to the urgency of stimulating the economy. On the monetary policy side, the PBOC is the only major central bank that is currently still easing, helped by lower inflation pressures compared to other countries. In April, the central bank cut the Reserve Requirement Ratio (RRR) for commercial banks operating within administrative areas and rural banks with an RRR above 5% by 25 bps, releasing CNY 530bn (USD 78.5bn) of liquidity. In May, the 5-year loan prime ratio, a benchmark rate for home mortgages was also cut by 15 bps to 4.45% to support the overall economy and house purchases. At the same time, at the end of April, President Xi pledged a strong rise in infrastructure spending in order to promote growth and employment. Such measures will mainly target the transport, energy and water management sectors, but some of the money will also flow into non-traditional spending such as data centres. By June, local governments already met their annual quota for issuance of special government bonds of CNY 3.65tn (USD 540bn). Such stimulus is out of ordinary and outpaces the issuance of 2020. Furthermore, more issuance is expected as CNY 1.5tn are expected to be frontloaded from the 2023 issuance quota. Additional measures have also been taken, from tax cuts to the recent creation of a CNY 500bn infrastructure investment fund that should be operational in Q3. Summing up all these actions, the fiscal boost to the economy should be above CNY 7tn, three times what we had in 2021.  

What have the authorities done for the real estate sector and is it enough?

The first half of the year has seen the implementation of multiple measures to shore up the property sector crisis. While these measures helped remove some of the pressure and are going to the right direction, Chinese developers are still suffering an unprecedented liquidity crisis that has already led to the default of big market players such as Evergrande. An ancient Chinese proverb says, “think thrice before you act” and this seems to be the strategy applied by authorities so far as their response has been gradual and has avoided a big bazooka-style response. Much harm has been caused by not acting decisively. To convince investors and homebuyers and prevent additional negative spill-overs, a game-changing response is required. Lately, some buyers have stopped mortgage payments over around 300 projects that were not delivered on time. In order to prevent this loss of confidence from expanding further, authorities have acted at both local and central government level. At local government level, the Henan province, the province with the highest share of unfinished projects, instructed its asset manager company (AMC) to provide support to troubled property developers, giving priority to unfinished projects. At central government level, the latest news suggests that the PBOC together with Chinese State-owned banks are setting up a State-owned real estate fund with a capacity of CNY 300bn. While this amount is not enough to solve the crisis, it is still a useful tool that could be replicated/upsized if successful. Going forward, we would like to see more of these actions from AMCs or stability funds as well as from State-owned enterprises (SOEs) taking over projects from troubled developers. Finally, a healthy pick-up in property sales is also necessary to ensure market stability over the medium term. While this is dependent on how the pandemic unfolds, we are confident that the authorities remain committed to sustain a sector that accounts for around 25-30% of the economy. However, a more powerful and firmer policy response is needed to stem the property crisis and restore investor confidence so that we finally move on to the next chapter. 

Can the economy recover in the second half of 2022? 

The economy already rebounded in June when lockdowns were lifted. Manufacturing PMI moved to 50.2 from 49.6, while both CAPEX and retail sales growth accelerated. Going forward, we believe that the economy can rebound from the depressed levels of the second quarter given the strong infrastructure stimulus. Of course, the re-imposition of hard lockdowns affecting large portions of the domestic economy like in Q2 would weigh on consumer spending and industrial activity, weakening the expected economic rebound. We don’t expect China to exit its zero-tolerance Covid policy any time soon, at least until the end of the 20th Communist Party National Congress in Q4. As President Xi is looking for a third term, he cannot afford a pick-up of deaths from Covid infections. As vaccinations of vulnerable people are continuing, by the time of the Congress we should also see a noticeable pick-up in the number of vaccinated people, and this should also help with potentially exiting the zero-tolerance strategy. From April to July, the share of population older than 60 that has received a booster shot increased from 52% to 64%. While we await more evidence on this subject, we remain confident that the Chinese authorities have the fiscal and monetary tools to stimulate the economy, and even do more if needed.

Author: Andranik Safaryan, Portfolio Manager of MainFirst Emerging Markets Corporate Bond Fund Balanced & MainFirst Emerging Markets Credit Opportunities Fund

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