China: Subdued 2022, brighter 2023
- Re-opening of the economy will boost major activities
- December’s retail sales is projected to be -8.5%yoy (from -5.9% in November)
- Industrial production may have slowed to 0.5%yoy (from 2.2%)
- FAI is expected to grow 4.8% for 2022 (from 5.3% up to November)
- We lift our 2023 GDP forecast to 5.5% (from 4%)
Prior to the zero-Covid policy turnaround in December, the Chinese economy was seeing a housing market slump, tepid consumption, and weak external demand. Our Nowcast points to around 2.4% growth in 4Q22. That would leave the full-year expansion at 2.9%.
Reopening-induced Covid spread has likely resulted in contraction in consumption. Anecdotal evidence shows rocketing infections, with some regions seeing infection rates exceeding 60-70% as of late December. The result has been widespread voluntary home confinement either due to illness or to avoid contracting Covid. Subway trips in major cities plunged by 40-50%yoy last month.
Consumer sentiment stayed sour, with expectation of future income slumping to levels unseen since the series inception in 2001. Meanwhile, the official services PMI fell for sixth successive month to 39.4 in December, the lowest reading since February 2020.
Factory production was also capped. December’s manufacturing PMI tumbled to 47.0, the lowest print since the initial pandemic lockdowns in early-2020. A precipitous decline in the production index (44.6) reflects severe disruptions in the face of labor crunch. Logistics have been thrown into disarray, lengthening suppliers’ delivery times tremendously (40.1). Languishing overseas demand on the back of looming global recession pressure was an added constraint. Global composite PMI dropped for a 5th consecutive month in December, with new orders falling.
Fixed asset investment
Fixed asset investment continued to expand, albeit at a moderate pace. The slowdown was partially attributable to the halt in some construction work due to labor shortages. New waves of infections also disrupted supply chains for building materials. Headline FAI growth was meanwhile dragged by property investment as evidenced by leading indicators. In particular, new-home sales by top 100 developers declined 30.8%yoy in December after falling 25.5% previous month. Growth in new floor space slipped further into contraction. While recent policy relaxation should help stronger builders avoid default, a sustainable recovery in real estate investment will hinge on a solid recovery in housing demand.
Dark before dawn
Near term, the China’s economy will experience volatility as the virus continues to spread beyond major cities. Increased travel during the Lunar New Year holidays may cause an explosive surge of infections in rural areas where medical resources are less abundant. But 4Q22-1Q23 is likely the nadir, in our view. The swift rollback of Covid restrictions has not only brought forward the initial reopening disruption, but also an earlier arrival of herd immunity. Measures taken hitherto such as interest rates cuts and tax breaks to deal with the malaise in the economy will filter through as soon as the initial infection wave retreats.
Adding to the momentum is a strong pro-growth shift in economic policy by the new leadership team. At the Central Economic Work Conference policymakers pledged to revive domestic demand and support the private sector, a marked shift from recent years. Efforts are also gathering pace to aid the beleaguered housing market that contributes one quarter of GDP. Scrapping quarantine for international travelers may rekindle foreign investor enthusiasm, following a sharp fall in inbound M&A transactions and record low levels of greenfield investments in 2022. All this has prompted us to revise up our full year GDP forecast for 2023 to 5.5% from 4%.
Rates are quickly repricing amid growing optimism around the economic outlook and reopening. Chart below shows the implied policy rate curve has shifted up considerably from 3Q22.
Our inclination is that PBOC’s monetary policy will remain supportive. Benign inflation (December CPI: 1.8%; PPI: -0.7%) leaves room for further interest rate reduction, which is critical in facilitating the issuance of extra government bonds this year to finance infrastructure projects. Policymakers at the Work Conference promised to support “fundamental housing demand”. To that end, PBOC may further lower mortgage rates and down-payment requirements. Meanwhile, the potential easing of the Three Red Lines could reduce developers’ financial stress.
Financial guarantees might also help, with banks to extend debt financing support and provide more flexible repayment options for private companies. Other measures include subsidies and loans with preferential interest rates for investing in qualified projects (i.e., infrastructure, artificial intelligence, innovation and high tech as well as green energy projects identified in the 14th FYP).
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