Although recent data from China points to a broad-based recovery, downside risk to growth remains since business confidence has not returned and liquidity has not bounced back solidly yet.
- Balancing steady growth and tackling debt reduction and asset bubbles
- Three policy options and their market implications
- Risks to monitor – three factors
At present, the Chinese central bank appears to be happy with its policy stance, keeping M2 money supply growth in line with nominal GDP growth (see Exhibit 1), even though its actions have so far only prevented a contraction, and not a sustained recovery, of liquidity.
Can the balancing act continue in 2020?
Policymaking was a constant balancing act in 2019 between the need for cyclical stimulus to protect GDP growth and structural control of the debt and asset bubbles.
The latter implies measures to finish the financial clean-up that Beijing started in 2017. These conflicting objectives have driven the recent strategy of selective policy easing.
So, what are the possible policy and growth outcomes in 2020?
Core scenario – 60% probability
- Policy status quo. Beijing continues to ease policy selectively alongside efforts to revamp the financial system. Total credit growth and infrastructure investment are expected to pick up moderately to 10% YoY and 8-10% YoY, respectively. Real GDP can be expected to grow at 6.1% YoY in this scenario.
- Market implications: Mildly positive for both Chinese stocks and government and high-grade bonds, but not necessarily for corporate bonds due to concerns about credit risk and defaults.
Bullish growth case – 20% probability
- Unexpected strong recovery in the car and electronics sectors – the two largest manufacturing sectors in China; resilience in the property sector; receding trade war risk boosting exports, capital expenditure and corporate profits. GDP could grow by more than 7% YoY.
- Market implications: Negative for fixed income, upbeat for equities in the beginning, but the market rally could be short-lived as bullish growth would prompt Beijing to stop policy easing.
Bearish growth case – 20% probability
- Beijing’s balancing act fails, leading to a worse-than-expected slowdown. If GDP growth falls towards 5% YoY, how would Beijing respond? We see two possibilities:
- Another mega stimulus package (probability 5%)
- Beijing is quite aware debt is too high for the country and has shown a strong debt-reduction resolve even at the expense of lower growth
- Market implications: Mostly bullish for both stocks and bonds.
- Increasing the selective easing doses (probability 15%)
- More selective cuts in interest rates and the reserve requirement ratio
- More fiscal support, especially infrastructure spending
- Market implications: Bearish for risk assets, bullish for government bonds.
Monitoring growth risk
Firstly, there is the trade war. Any rollback of US tariffs should help lift Chinese exports. Stabilising trade tensions would also help improve sentiment and growth from domestic sources.
Secondly, watch domestic credit and investment. Rising credit growth, though expected to be slow, should help ease the liquidity constraints on the corporate sector. However, the question remains how much the private sector would benefit from selective easing since banks are still not lending much to the private companies (Exhibit 2).
Thirdly, monitor the car sector. Car output accounts for about 5% of GDP. Its contraction by more than 10% between late 2018 and 2019 dragged on GDP growth by more than 0.5 percentage points. So even a bounce back to zero would remove a big drag on growth. The two major shocks hitting the sector in 2019, namely the removal of tax benefits and falling consumer confidence, are fading.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.