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Jennifer James, emerging market credit portfolio manager, considers how policies enacted by China’s government towards COVID, consumption and credit are likely to shape China’s near-term trajectory.
The policies enacted by the government to address these three broad categories – COVID, consumption and credit – help explain China’s current situation and will likely shape its near-term trajectory. Longer-term, China is seeking to evolve its economy through innovation; to thread the needle between profits and protecting the welfare of its people. The sheer scope and challenge involved in evolving such a large economy is formidable; no other country has the ability nor the ambition to undertake what China is doing. However, these efforts can lead to unintended consequences. Indeed, the simultaneous policy shocks across different sectors that we have seen thus far have likely caused an acceleration of an otherwise natural economic slowdown, eroding consumer sentiment, and contributing to recent market instability.
China has pursued a zero-tolerance strategy towards COVID-19. Entire metropolitan areas have been locked down following the detection of cases. It has been indicated that an 80-85%1 vaccination target would need to be fulfilled before there are any changes to this strategy. Manufacturing activity has not been shielded from this approach, with severe restrictions imposed on the industrial hub of Guangdong. Such an approach, which can instantly choke economic activity, only to turn the economy back on like a light switch when cases subside, is disruptive. This is because activity is often easier to cease than to restart. Soaring global freight rates are indicative of the congestion caused by China’s COVID intolerance, which included the closure of Ningbo-Zhoushan, the world’s third busiest port, reportedly over one positive case.
Source: Bloomberg, NCOVCNPV Index (China), NCOVGBPV Index (UK), NCOVUSPV Index (US), NCOVFRPV Index (France), 8 August 2021 to 27 October 2021
Source: Bloomberg, WCI (World Container Index) Composite Container Freight Benchmark Rate (WCIDCOMP), 21 October 2020 to 21 October 2021
Chinese retail consumption remains weak. It has fallen far short of expectations that it would improve as restrictions eased. Evidence of a rebound has been negligible, with China’s post-COVID retail sales growth remaining well below the 8%2 pre-pandemic growth rate, recorded in December 2019.
Anaemic consumption may reflect the greatest burden of the COVID economic fallout being shouldered by those most susceptible to it. Low earners represent 40%2 of the population and labour market data suggests their income has not increased in line with more lucrative professions such as technology and financial services.
Source: Barclays Research, Special Topic: China, Policy Evolution, September 2021
Similarly, household saving rates rose in response to COVID lockdowns but have not been used by savers to fuel a consumption-based recovery as the economy reopened. This may reflect the disruption and uncertainty resulting from the zero-COVID approach, where sudden restrictions being imposed make it difficult to plan for leisure spending. Additionally, it could indicate that consumers are cautious about their future employment prospects.
Source: Barclays Research, Special Topic: China, Policy Evolution, September 2021
Another factor potentially weighing on consumers’ appetite to spend is the government’s crackdown on property. The government has stated that they do not wish housing to be a speculative market. Property is of societal significance in China, representing 23.3% of GDP3. Policies implemented to stabilise the housing market are beginning to bear fruit, albeit they appear to have overshot and are dampening this engine of growth.
Source: Nomura Global Research, China: Property-related indicators broadly worsened in September, October 2021. A city’s tier is calculated from an average of its political standing, population and GDP. Tier 1 reflects the biggest cities.
We have already seen some of the risk from a slowdown in the property sector, combined with stricter government policy on debt levels, manifest itself in the troubles at Evergrande, the huge Chinese property developer. Systemic risk from the Evergrande saga is likely to be low given that banks have limited direct exposure to property-related loans and China is likely to contain any fallout from being excessive. Nevertheless, support is more likely to be aimed at homebuyers than company bailouts per se, so equity and credit markets may have to absorb some losses. We can see the reaction in credit markets, with China’s credit spreads gaping wider. So far, there has been limited contagion beyond China, with broader emerging market high yield and investment grade spreads barely changed.
Source: Bloomberg, JPMorgan CEMBI = JPMorgan Corporate Emerging Market Bond Index, JBCDCBZW Index (Broad Diversified); JBCDIGZW Index (High Grade or Investment Grade); JBCDHYZW Index (High Yield); JBCDCNZW Index (China). 1 October 2020 to 21 October 2021
Attempts to tackle high debt levels in property form part of an overall drive to rein in credit growth. Major policy actions have been enacted to support the leadership’s credit tightening agenda, including2.
China has enjoyed decades of impressive debt-fuelled growth. Rising debt as a percentage of gross domestic product (GDP) has had a positive relationship with Chinese GDP per capita. The risk to the wider world is that China’s desire to deleverage leads to slower domestic growth, with knock-on effects to global growth.
Source: Bloomberg, CHBGDTOP Index (R1), GDCCPCHN Index (L1),31 December 2004 to 31 December 2020
1Source: Deutsche Bank, Exit Strategy Policy Tracker, October 2021