China: Delta worries dim outlook; policy easing warranted
- Recovery under pressure as retail sales, industrial production and FAI growth slowed in July
- A zero-tolerance approach helped to contain the delta variant outbreak
- But quarantine and lockdown will dent consumption and economic growth in 2H
- Extreme weather conditions, shortage of computer chips and electricity hamper production
- Implications for investors: We see scope for another reserve ratio cut in the coming months
July’s data suggested China’s roaring recovery from the pandemic was losing steam. Growth in industrial production fell for a fourth straight month to 6.4% YOY, compared with 8.3% in June. Fixed asset investment increased 10.3% YTD in July vs 12.6% in January-June. Retail sales retreated to 8.5% YOY from 12.1%, confirming our cautious view on the sustainability of the June’s rebound. The surveyed jobless rate edged up 0.1%ppts to 5.1%.
Among others, concerns about the delta variant will weigh on retail spending and economic growth in 2H. The latest wave of cases erupted in Nanjing and spread to more than half of the country’s 31 provinces. Provinces with local communities currently classified as medium- and high-risk account for more than one-third of national GDP. The deteriorating outbreak has triggered tightening of virus controls. Millions are shelving travel plans during the peak summer season. High-frequency indicators of mobility from domestic flights to road congestion already show signs of slowing.
Past outbreaks suggest regions more affected by infections will experience slower recoveries in consumption and household income. We noted aggregate real income per capita growth of 5.4% in 2Q21 (2-year average growth) was still 1.4%ppt off the 1Q19 level. The pinch extended beyond catering and tourism. Some refiners reportedly scaled back operations as the decline in traffic crimped fuel consumption.
New infections have been largely contained in areas with heavy industrial activities so far. Hence, we do not expect the delta variant to interrupt the manufacturing sector severely. But there are risks on the horizon, evidenced by the recent moderation in leading indicators. The decline in July’s PMI, for instance, was concentrated in the polluting industries such as ferrous metals smelting. This, alongside strict limits on coal usage, underscored the effects of China’s de-carbonization drive. Meantime, extreme weather conditions such as high temperatures and flooding in some areas affected production. A shortage of computer chips and electricity will also put a damper on output.
Externally, reopening is propelling recoveries in manufacturing in major trading partners – dampening China’s export share. Already, we reckon the recent fall in shipments was largely driven by the likes of non-pandemic products including household appliances and furniture. By destination, exports to the US weakened a fifth straight month in July. EU-bound trade also retreated sharply.
The closure of the Meidong terminal, which processes 25% of the cargo that passes through Ningbo-Zhoushang port, will aggravate port congestion and delay planned sailing. The slowdown in exports will be more pronounced in the coming months as base effects wear off.
All told, more fiscal and monetary support is warranted to put a floor beneath economic growth. We expect the local administration to quicken bond issuance to fund infrastructure projects. Net local government special bond issuance in 1H only amounted to 28% of the annual quota. On the monetary policy front, we reiterate our view that PBOC may step up liquidity injections amid concerns over the faltering recovery and looming municipal bond supply (see “China: Inflation and monetary policy outlook”, 27 May). Inflation doesn’t seem to be a constraint, with CPI growing a meagre 1% in July.
Echoing our call is the Q2 Monetary Policy Implementation Report released last week. The authority pledged to keep liquidity ample and step up support for small firms and the manufacturing sector. In our view, the likelihood of another RRR cut is increasing, particularly since banks’ excess reserve ratio is now hovering at the lowest level since 1Q18.
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