Macro Insights Weekly: Absence of Stagflation in China deserves Re-Rating

China/HK equity market should deserve a re-rating in 2H22 due to absence of stagflation.
Group Research, Chris Leung, Samuel Tse12 Jul 2022
  • Stagflation is not a concern for China comparing to the West
  • Optimism stems from: (1) potential reduction of tariffs on Chinese imports to the US
  • (2) gradual relaxation of zero covid policy across China
  • (3) fiscal stimulus should begin filtering through the real economy in 2H22
  • Annual GDP is projected to conclude at 4.2%
Photo credit: AFP Photo

Commentary: China/HK equity market should deserve a re-rating in 2H22 due to absence of stagflation

The world may have preoccupied too much with forthcoming recession in the US despite persistent tightness of labor market and elevated inflationary pressure.  China’s inflation pressure, on the contrary, are very subdued as evidenced by the mild increment of CPI by 2.5%, alongside the moderation of the PPI thanks to recovering domestic supply-chain and discounted oil imports from Russia.  The breakdown of CPI saw mild upward pressure on food prices driven by pork prices, but it is highly unlikely it will spike up to the threshold resembling the inflation situation of US and UK.  

The pressing issue of China is growth deceleration.  In fact, 2Q GDP probably only advanced by a meagre 0.9% thereby concluding GDP growth at 2.7% in 1H22, far below the official target of 5.5%. The market however should not focus on China missing official target. Forthcoming  positive development include: (1) the potential reduction of tariffs on Chinese imports to the US by the Biden Administration; (2) gradual relaxation of zero  covid policy across China (quarantine time has recently been halved for inbound travellers to one week ) alongside the rebound of industrial production (up 0.7% YoY in May) and exports (up 16.9% YoY) , which is consistent with rebound of Services PMI and Manufacturing PMI; (3) positive impact of fiscal stimulus on the real economy shall surface apparently in 2H22 as evidenced by uptick seen from corporate borrowing and infrastructure spending. In particular, new corporate medium and long-term loans soared to RMB1.5tn last month, the highest since January. Infrastructure investment accelerated to 6.7% in the first five   months from 6.5% in January-April.  Annual GDP is projected to conclude at 4.2% assuming the economy to advance 0.9%, 5.3% and 5.5% respectively in 2Q, 3Q and 4Q.  

The PBOC could have proactively cut interest rates and reserve requirement ratio in the past 6 months. The authority had chosen instead to protect the resilience of RMB, which substantially outperformed the JPY and EUR despite narrowing rate spread with the USD, dwindling economic growth alongside foreign reserves declining USD179 billion in 1H22 to USD3.07 trillion.  This is an intelligent policy choice because currency stability is a prerequisite for asset prices re-rating ahead.

The absence of stagflation in China warrants higher policy flexibility relative to western counterparts.   This factor alone should deserve a re-rating considering valuation (PE ratio) of Shanghai Stock Exchange Composite Index and Hang Seng Index are trading at a three-year low of 13.5 and 7.8 respectively. Both indices had already rebounded by 14.8% and 14.7% from the respective year-low. Should China economic growth surprise on the upside ahead, the re-rating of Chinese assets could be explosive. In another scenario, if US recession were to arrive sooner justifying rate cuts by the Fed, the PBoC will likely loose domestic monetary policy in tandem this round at ease.  Both scenarios are positive for China/HK equities.

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Chris Leung

Chief China Economist - China & Hong Kong 首席中國經濟學家 - 中國及香港

Samuel Tse 謝家曦

Economist - China & Hong Kong 經濟學家 - 中國及香港

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