GDP growth slowed from 5.3% YoY in 1Q to 4.7% in 2Q, with sequential growth decelerated from 1.6% QoQ in 1Q24 to 0.7%. The slowdown was attributed to extreme weather, flooding, and insufficient domestic aggregate demand. Weak credit demand and conservative consumption sentiment signal the need for further policy easing. Mild inflation leaves room for rate cuts. We anticipate the PBOC will cut the Reserve Requirement Ratio (RRR) and Medium-term Lending Facility (MLF) as early as this quarter. The Third Plenary session is being held from today to Thursday in Beijing, focusing on new quality productive forces and supporting the domestic economy in the long run.

1.  Trade

External trade was the growth engine in 1H24. China's total trade (exports + imports) exceeded RMB 21 trillion for the first time in history. The surging trade surplus hit a historical high of USD435bn in 1H. Export growth accelerated from 7.6% YoY in May to 8.6% in June, resulting in a 3.7% YoY YTD increase for the first half of this year. High-tech products, electronics, and automobiles were among the top-performing products.

The latest EU and Indonesia tariffs on China's EV exports impact are expected to have a limited impact. EUR 10 billion worth of EV exports contributed only 0.5% to China's total exports in 2023. Chinese brands remain price-competitive even with the tariffs in EU region. Meanwhile, exports to Indonesia accounted for only 1.6% of total Chinese EVs exports.

Import growth decelerated from 2.9% YoY YTD in May to 2.0% in the first half of this year. The decline in June was primarily due to reduced imports of agricultural products, crude oil, and natural gas. In contrast, ongoing infrastructure investment and progress in completing unfinished homes are driving increased imports of raw materials such as copper and iron ore.

2. Production

Industrial production increased 0.4% MoM in June but slowed to 6.0% YoY YTD from 6.2% in May. In particular, industrial robotics and integrated circuits registered double-digit growth, supported by government efforts to upgrade production capabilities. Meanwhile, EVs and high-tech manufacturing saw production increases of 37.0% and 8.8%, respectively, thanks to improving external demand. This was in line with the ongoing expansion of the SME exporters-focused Caixin Manufacturing PMI.

3. Investment

The state sector continued to drive recovery. SOE fixed asset investment (FAI) grew by 6.8% YoY in the first half of 2024, outpacing the headline figure of 3.9% YoY YTD. Government initiatives on equipment renewal also contributed significantly. FAI in the computer, communication, and electronics sectors increased by 15.3% YoY YTD. Infrastructure and transportation segments, including railway and aircraft, also performed well.

However, the private sector remained sluggish. Property investment remained as the main drag with a contraction of -10.1% YoY YTD, and residential “floor space started” decreased by
-23.6%. Real estate developers are still prioritizing completing unfinished homes ahead of new investments. On the liquidity condition, the contraction of sources of funding only showed marginal improvement from-26.0% to -22.6%. Likewise, residential inventory retreated from the peak of 31.8 months in March, albeit staying above the 5-year average at 27.7 months in June.

4. Consumption

Retail sales growth decelerated from 3.7% YoY to 2.0% in June or 3.7% in the first half of 2024. Big-ticket items such as automobiles and luxuries were lacklustre amid negative wealth effects from asset markets. Overall retail sales ex-auto sales stood at 4.1% so far this year. There was little improvement in construction materials due to property routs. On a positive note, leisure spending, such as catering, sports, and entertainment, remained buoyant. This was consistent with resilient domestic travel traffic and revenue for experiences and leisure activities in the Dragon Boat Festival.

The recovery in consumption sentiment will hinge on the labour market condition. While the unemployment rate stayed at 5.0% in June and remained below the government’s target of 5.5%, disposable income growth slowed from 6.2% YoY YTD in 1Q to 5.4% in 2Q. Amongst all, wages and salary saw a noticeable deceleration.

5. Money supply

The weak money supply growth in June indicated tepid aggregate demand. Overall deposit growth slowed from 6.7% YoY in May to 6.1% in June, with M2 growth further decelerating from 7.0% to 6.2% YoY. Meanwhile, the contraction of M1 extended from -4.2% to -5.0% YoY. This weaker inclination to hold short-term deposits indicates low business investment and capacity expansion confidence.

Credit demand remained sluggish. Overall loan growth slowed further from 9.3% to 8.8% in June, marking the slowest growth rate since 2001. This deceleration was broad-based. In the first half, new increases in mid- to long-term household loans contracted by 19.2% YoY in the first half, suggesting weak home sales and ongoing early mortgage repayment.

Corporate borrowing fared no better due to high real funding costs. The new increases in mid- to long-term corporate loans dropped by 16.8% YoY. Excluding government bonds, total social financing growth slowed from 8.2% in January to 6.7% in June. Meanwhile, state borrowing was supported by issuing CNY 1 trillion in ultra-long special sovereign bonds.

6. Inflation

Mild inflation provides the PBOC with room to cut rates. Consumer price slowed from 0.3% YoY in May to 0.2% in June despite a low base comparison. On a sequential basis, CPI fell by 0.2% MoM. The decline in food prices, slightly worsening from -2.0% YoY to -2.1% in June, was the main drag, though a rebound in pork prices offset further declines in fresh fruit prices. Core CPI stayed steady at 0.6%. Consumer goods, particularly durable goods, saw more apparent decreases. Residential rents were also stressed amid the property market routs.

The decline in factory gate prices (PPI) narrowed from -1.4% YoY in May to -0.8% in June. Upstream mining and quarrying prices turned positive for the first time after 15 months of decline. Raw material prices accelerated from 0.5% YoY to 1.6% in June. However, downstream prices continued to face challenges, with automobile prices dropping amid intense price competition and overcapacity.

7. Policy

On the monetary front, we expect the PBOC to lower the RRR by 50bps this quarter to stir credit growth. Additionally, the opportunity for a benchmark rate reduction has emerged, aligning with the rate cut cycles of major central banks. The CNY exchange rates may take a breather, which could help mitigate subsequent capital outflows. Notably, the CNY has outperformed both developed market (DM) and emerging market (EM) currencies this year, recording only a 2% depreciation against the USD, acting as a global currency stabilizer

8. Third plenum

The much-anticipated Third Plenary Session of the 20th Communist Party of China Central Committee is underway in Beijing from July 15-18. The areas closely watched include developing strategic industries, fiscal system reforms, and further opening up to foreign investment. The communiqué, which is expected to follow the conclusion of discussions on July 18, is anticipated to outline initiatives addressing economic priorities.

8.1 Historical context

The Central Committee typically holds seven plenums each five-year term, with the first two focusing on new leadership and personnel, and the third often heralding significant reforms that impact China’s trajectory. Notable precedents include 1978's economic opening under Deng Xiaoping, 1993's decision to shutter loss-making state firms, 2002's post-WTO domestic liberalization, and 2008's rural reforms addressing urban-rural gaps. Meanwhile, in 2013, market allocation reforms were accelerated while security priorities were being heightened under President Xi Jinping (see appendix). We believe “reform and opening up” will remain the central in this Third Plenary session.

8.2 Policy priorities – new quality productive forces

One important discussion topic will likely be advancing the cultivation of "new quality productive forces" - a concept defined by President Xi to refer to strategic emerging sectors vital for powering innovation-driven growth. A key example is semiconductors - a core industry facing significant bottlenecks due to limited access to critical inputs from US trade restrictions. The notable 30% drop in China's chip imports since 2021 underscores the need to strengthen self-sufficiency in this strategically important sector. Through resolute efforts to develop these new forces and accompanying economic reforms, Beijing aims to demonstrate its resolve to minimize vulnerabilities arising from geopolitical tensions as some foreign companies recalibrate supply chain allocations away from China.

8.3 Policy priorities – tax reform

Reforms may also address long-standing budgetary imbalances between central and local administrations. Targeted fiscal policies are expected to address the entrenched unequal revenue and spending relationships, where data showed municipalities generated 54% of income yet shouldered 86% of expenditures for 2023. Reforms could empower local administrations to retain more major tax receipts to stabilize budgets aligned with more sustainable fiscal means, as land sales receipts weighing heavily on local budgets decreased sharply from 8.3% to 4.6% of GDP during 2020-2023. Such tax adjustments may also complement the goals of addressing inequality via luxury levies as well as decarbonization through energy duties, while incentivizing consumer demand-driven rather than perpetual infrastructure-focused growth.

8.4 Policy priorities – foreign investment

As FDI declined for the 13th consecutive month in June, policymakers will likely reassure foreign investors of China's opening agenda. FDI-funded projects are a pivotal source of job creation, especially in manufacturing hubs that underpin near-term economic recovery. Structural shifts also necessitate continued liberalization. Projections indicate China's aging demographics and youth expenditure patterns could diminish national savings levels over time. Fintech development and improved access to credit for spending will exacerbate this trend. These converging forces signal China's colossal savings pool, presently supporting capital controls, may erode in the longer term.

Considerable scope remains for further opening. International investment position data reveal that China’s gross direct investment equals a mere 35% of GDP, far below the 85% for the US. Disparities are even more pronounced regarding portfolio investments.

In sum, the policy blueprint to emerge from the Third Plenary session aims to comprehensively strengthen China's economy at a pivotal juncture. By developing new industries, reforming fiscal systems, and further opening up to foreign capital, the measures seek to bolster innovation, sustainability, and global integration. Successful implementation of these reforms over the coming years will be essential for China to navigate domestic and external economic challenges.


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