It’s tightrope walk time for China’s monetary authorities: do they ease further to irrigate the green shoots of recovery, or could their resolve to keep tight control of the property market put the kibosh on broader economic growth?
- GDP growth revived in Q2
- Central bank to keep easing bias
- Property unlikely to receive more stimulus unless it – or the broader economy – needs rescuing
Gross domestic product (GDP) grew at 6.2% year-on-year in second quarter 2019, suggesting to me that the green shoots of economic growth are reviving and nominal GDP is recovering.
In my view a full-year 2019 growth rate of 6.2% YoY should be achievable, but more policy stimuli will be needed to achieve it.
Amid the need for further easing, Beijing still appears resolved to cap debt growth through its cautious property market policy. This policy, while structurally positive for the Chinese economy and financial markets, raises a potential risk of tightening too soon. That would wreak havoc on the economy.
The People’s Bank of China (PBoC) is trying to counterbalance this policy risk by keeping an easing bias.
What to expect in the second half of 2019
My view is that during the second half of the year we can expect more cuts in banks’ reserve requirement ratio (RRR) and lending facility interest rates, but not in benchmark interest rates.
Such moves would put downward pressure on Chinese bond yields and corporate spreads in the coming months. While this benign macroeconomic backdrop should also benefit Chinese stocks, trade-war uncertainty and fragile economic sentiment will create market volatility and keep Chinese stocks in a trading range, despite the expected foreign inflows due to the inclusion of Chinese assets in the international benchmarks.
China’s economy ended the second quarter on a high note, with some major macroeconomic indicators recovering in June from their weakness in April and May
Exhibit 1: Economic green shoots reviving at the end of second quarter 2019
Real GDP growth slowed to 6.2% YoY in Q2 2019 from 6.4% in Q1. Even if growth stabilises at between 6.0% and 6.2% year-on-year (YoY) in H2 2019, China will achieve a full-year growth rate of 6.2%, as we forecast. If the downside growth risk rises unexpectedly, Beijing will likely react with more assertive policy easing responses.
Nominal GDP growth recovered to 8.3% YoY from 7.8% YoY in Q1 2019, but it is not a sign of solid recovery in demand or in corporate pricing power. The recovery was driven by a rise in prices due to a surge in pork prices (because of the African swine flu) and a jump in iron ore prices (because of a major accident in Brazil that led to mine closures). These one-off temporary shocks will not help nominal growth again.
Real estate is the principal driver of growth
The real estate sector was the key driver of growth in Q2 2019, with construction and housing starts holding up surprisingly well (Exhibit 2), averaging 9.0% and 11.0% YoY, respectively. The correction in the property market has also been shallow so far in 2019, with the decline in sales volume narrowing to -2.2% YoY in June from -5.5% YoY in May.
Exhibit 2: Chinese construction and housing starts held up will in the second quarter
The overall picture
The revival of green shoots indicates only the start of economic stabilisation, not a return of robust growth.
While solid construction activity supports the metals and mining sectors (Exhibit 3) and provided a boost to overall growth, many other sectors did not fare so well.
The improvement in fixed-asset investment in June was mainly boosted by real estate. Infrastructure investment ticked up in June, but remained quite weak by historical standards. Manufacturers were still dragging their feet in the face of trade uncertainty and its impact on the domestic sector.
Exhibit 3: A rise in output in mining and metals in the second quarter driven by construction activity
Despite the nascent signs of economic stabilisation, it is remarkable that Beijing still insists on tightening its housing policy. It has slashed subsidies, called on local authorities to clamp down on housing price inflation and tightened developers’ access to financing via trust loans and offshore bond sales.
Granted, these moves have been made on the back of still-strong mortgage borrowing (18% YoY) and rising housing prices. But since property is one of the most indebted sectors, the cautious property market policy reflects Beijing’s resolve to keep debt growth under control. This is structurally positive for the Chinese system.
Beijing’s self-imposed policy constraint on easing carries a potential risk of tightening too early and killing off the economic green shoots.
To balance this, the PBoC is expected to keep its selective easing bias.
Easing of monetary policy by the US Federal Reserve would allow the Chinese authorities room to ease further by cutting the RRR and some quasi policy rates, such as the reverse repo rate, the medium-term lending facility rate and the standing lending facility rate.
Beijing remains wary of the risk that large-scale monetary easing would push more money into property and inflate a real estate market bubble.
For this reason, while total credit is expected to rise further in H2 2019 to support growth, property is unlikely to receive more stimulus unless it – or the broader economy – needs rescuing.
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