China: Strong headwinds

Domestic activities stabilized but downside risks have emerged

The Jan-Feb data suggest that the overall economic condition stabilized somewhat. Export-led industrial production growth rebounded to 7.5% YoY from 4.3% in Dec as global demand was strong.

Exports grew by 16.3% YoY and posted the 16^th straight month of double-digit export growth. The supply chain was largely unaffected by the renewed COVID outbreak in Jan-Feb as migrant workers did not move away from their working province during the Lunar New Year. Yet, various potential downside risks warrant concerns.

Firstly, the ongoing COVID outbreak has led to lockdown in major cities, particularly Shenzhen and the wider Guangdong Province. Many giant WMNCs have already shut down the production line in Shenzhen. Factories in the province accounted for 23% (USD795bn in 2021) of the nation’s exports. Leading indicators such as new export order PMI stayed below contraction zone for the 9^th consecutive month. Oil refinery run rate also stays at a 2-year low of 55.58%. Secondly, global demand may weaken amid rate hikes across major central banks. Our Chief Economist expects the US Federal Reserve to raise interest rates by at least 5 times this year.

Retail sales rebounded to 6.7% YoY in Jan-Feb from 1.7% in Dec. Sales of big-ticket items such as automobiles grew by 6.9% in Jan, accelerated from 2.0% in Dec. Yet, the performance has turned south again. Daily COVID test and in-restaurant dining ban are now in-placed in major cities. Subway and traffic congestion indices fell significantly. The negative wealth effect from weaknesses in asset markets and rising jobless rate (from 5.1% in Dec21 to 5.5% in Feb22) will also translate into weaker consumption power.

Fixed asset investment improved to 12.2% YTD in Jan-Feb from 4.9% in Dec on the government’s effort in fiscal spending. Infrastructure investment rose by 8.1% from 0.4%. Looking ahead, the related investment will speed up. The NDRC has approved RMB238.8bn worth projects YTD, up by 77.6% YoY. Based on our analysis (see “China: NPC signals front-loaded policy support”), stimulus this year will reach 7.7% of GDP (include off-budget financing and government funds alongside special local bonds) to support the economy. Key investment areas will consist of food and energy security. Thanks to sector-specific tax rebates/tax breaks, new infrastructure (high-tech) investment will also accelerate. The local governments have also front-loaded the special bond issuance to fund these projects (RMB484bn).

On the contrary, property investment fell to 3.7% YoY in Jan-Feb22 from 4.4% in Dec21 amid China’s continuing effort in Common Propensity. Some policy fine-tunings have been deployed to help developers deliver presold homes and stimulate new purchases. Reportedly, commercial banks in Guangzhou have already cut the mortgage rate by 20bps. Yet, the impact has been muted thus far. Leading indicators like growth in floor space started to fall by the 9^th straight month in Dec. Home sales remain weak due to adverse price expectations amid the urgency of fire sales from developers, worsening the financial position. HY bond yields stayed elevated.

Accommodative monetary policy

According to the Government Work Report, to support the economy and fiscal spending, the PBOC will ease the monetary policy further. New Yuan Loan grew by 5.5% YoY in Jan-Feb (to take away the new year effect) after recording YoY decline for two months in a row. M2 growth hovered about 9.2-9.8% in Jan-Feb, compared to the average of 8.5% in 2H21. We expect the money supply growth will be broadly on par with the nominal GDP growth this year. Also, modest CPI (0.9% YoY in Feb) leaves some room for the authority to ease further. The authority kept the 1Y MLF rate on hold at 2.85% today. We expect another 100-bp reduction in RRR and a 20-bp drop in 1Y-LPR (to 3.50%) in the coming months. The one-year LPR will fall by 5bps to 3.65% in Apr.

The impact of rising commodity prices is manageable

Elevated energy prices due to Russo-Ukrainian conflicts will affect terms of trade. For instance, China imported USD423bn worth of energy products last year, of which USD253 were crude oil. An average price jump from USD71 per barrel to USD110 this year will cut China’s nominal GDP by 0.8%. Given its neutrality over sanctions on Russia, China can partially offset the higher energy prices with cheaper imports from Russia.

In the past five years, China has run a deficit against Russia. Although Russia accounted for only 2.4% of China's total trade in goods in 2021 (2.7% in Jan-Feb22), Russia is the second-largest oil importer of China after Saudi Arabia. Also, China and Russia signed a new 30-year gas contract worth an estimated EUR103billion during the Winter Olympics. Energy trades could go through the RMB denominated Cross-Border Interbank Payment System (CIPS) which has processed around RMB80trn in 2021, up by 75% YoY. In fact, RMB-denominated trade between China and Russia has increased since 2014. Mirroring this, 13.1% of Russia's reserves are now in CNY. The PBOC and Russia have multi-billion-dollar currency swap arrangements that allow the two countries to provide liquidity for trading.

Also, the recent strong CNY helped secure imports of other major commodities such as coal, copper and aluminium at a lower cost. CNY has been trading at 6.31-6.37 since the war in Feb. The weighted average of the CNY exchange rate against a basket of currency (CEFTS RMB Index) rose by 16.8% since the trough of COVID in 2020. The CNY appreciated by 14.3% against IDR; China imports a substantial amount of coal from Indonesia.

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