The pandemic has certainly taken its toll on China, says Winnie Chiu, equities advisor at Indosuez Wealth Management’s markets, investments and structuring division.
Economic activities were severely disrupted. For one, China’s April manufacturing PMI (Purchasing Managers’ Index) fell to 47.4 from 49.5 in March, although there was a slight uptick to 49.6 in May.
“The market has essentially discounted a 1% drag in the full-year GDP for this year,” says Chiu. The central government, however, has openly said that they are not going to keep economic growth on the sidelines because of the Covid-19 lockdown, says Chiu in a May 12 outlook call.
On top of fiscal and monetary policies announced by the National People’s Congress (NPC) and Financial Stability Committee in March, the April Politburo meeting called for the most concerted efforts to stabilise China’s economy since 2018, with a focus on areas such as infrastructure investment, especially in transportation, energy and industry upgrading, says Chiu.
“So, assuming that the number of new cases will continue to come down and effective policy support will arrive between one and two months, then we should expect GDP growth in the second half to rebound to about 4.5% to 5%,” she adds.
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But Chiu also points to “positive developments” in China’s fiscal and monetary policies.
In addition, valuations are not demanding, she adds. “Politburo meetings actually set the tone on specific risks in the property market, as well as the Internet sector, which has undermined market confidence since last summer.”
For the very first time, China’s government will “optimise the supervision of property developer escrow funds”, says Chiu. These refer to pre-sales proceeds that are held by developers, which are bearing the brunt of the government’s bid to keep the property market under control.
“As these funds are being gradually relaxed, the default rates of property developers will come down. In turn, this will actually reduce the overall systematic risk in China and also the equity market risk premium in Chinese stocks,” Chiu adds.
On the Internet sector, which has been brutalised for the past year, the central government is also calling for new measures to promote “healthy development”, says Chiu. “This is another important signal for overseas investors and should help restore confidence, being that big tech is actually the largest segment within the MSCI China index and heavily owned by investors.”
Overall, Chiu recommends “a little bit more patience” with China. “Much of the easing that we have seen depends on how the government and the system will react to the Omicron situation. We need to see a little bit more development on how policies are being implemented, how social activities are being resumed and how supply chain disruptions will be resolved. So, for now, we are staying neutral [but] we are long-term positive.”
China’s fiscal deficit
Now, even with these various measures announced, China’s fiscal situation could deteriorate for the remainder of the year, writes Xu Jianwei, senior economist (Asia Pacific) at Natixis Corporate & Investment Banking.
“The slower-than-expected economy is exerting pressure on the government’s fiscal situation as Covid-19 clearly increases health-related expenditure. At the same time, the tax base is being eroded as consumption has sunk in April as companies are experiencing a more severe situation,” says Xu in Natixis’ Asia outlook on May 26.
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In the first four months of 2022, China’s fiscal general revenue year to date accounted for only 35.4% of the annual revenue budget. It was only slightly higher than that of the first four months in 2020 (34.5%) but significantly lower than that of 2021 (39.5%).
Xu attributes this to the “sluggish” property market, which has harmed local governments through plummeting revenue from land sales, a key source of their revenue.
“More specifically, the YTD government fund revenue, which mainly covers the land sales, was only 17.8% of the annual budget, which is smaller than that of the first four months of both 2020 (21.8%) and 2021 (25.7%) respectively. All in all, China’s fiscal policy is also suffering from the revenue side.”
Xu sees several possible scenarios for China in second half of this year.
Firstly, the government may have to cut spending in other fields that are less related to stimulating growth, such as limiting administrative costs or even cutting income growth for workers in public institutions.
But cutting costs may not be enough, adds Xu. The government may seek other financial sources to fill in the de facto deficit gap. It could cause an additional increase in the leverage ratio, says Xu.
Ideally, a more satisfactory result will come if China successfully lifts GDP growth and brings the tax base back on track, says Xu.
However, “this scenario seems challenging if lockdowns remain in place”.
Covid-19 policies in place till November
On that note, China could maintain its strict, dynamic zero-Covid-19 policy for a few more months, at least until it convenes the 20th National Congress of the Chinese Communist Party in November, says Professor David Li, director of the Centre for China in the world economy at Tsinghua University’s school of economics and management.
Speaking virtually at UOB’s Private Bank 2H2022 Investment Forum on June 3, Li thinks China will relax its stance after the twice-a-decade event is concluded. “After that, the policy of Covid-19 lockdowns will be significantly adjusted. After the congress, when the dust settles, when the new leadership is decided, policies will … push the healthy recovery of the economy.”
“China’s economic policies will become much more pragmatic, cautious, pro-market and pro-growth. [The central government] knows for sure that without continued economic growth, all the objectives of China will not be achieved,” says Li, who is a former member of the monetary policy committee of the People’s Bank of China (PBOC).
He believes China’s GDP growth of 2H2022 will reach 5%–6%, higher than the 4.5%–5% forecast by Indosuez’s Chiu.
With the government changing stance, the Chinese market has likely troughed, says Richard Tang, Asia equity research analyst, Julius Baer.
Tang adds that the pace of recovery will depend on the progress of reopening, “which is likely to be gradual”.
Reopening plays include Internet, auto and consumer stocks, Tang writes in a June 2 note, although he is quick to add that “it may be a long grind before the positions yield meaningful returns”.
Nonetheless, reopening beneficiaries should outperform in the near term. Tang expects Internet stocks to rebound the most, although they have become cyclical positions instead of core positions.
These names may face resistance once their share prices approach levels of early March, he adds.
The “so-called crackdown” of Internet companies has “already ended”, declares Tsinghua’s Li, alluding to the start of the crackdown on this sector when then Ant Group’s IPO in October 2020 was spiked at the last minute. “In the coming year, we are seeing a recovery of investor confidence in these companies.”
Reasons for the tough stance adopted by the Chinese government go beyond the occasional ribbing made by Jack Ma. “The rationale was mainly the concern that Internet companies were interfering with the politics of China … That really scared the top leadership.”
However, that concern has already been addressed, adds Li. “By now, Internet companies have zero impact on Chinese politics. The focus now is to restore investor confidence in platform companies. There will be a recovery of their valuations from now on.”
Similarly, Li thinks “significant policy adjustments” will offer reprieve to the Chinese property market within the next six months to a year, given how speculative fervour among property buyers has been snuffed out.
“From now on, the very tight policies against property will be easing off. Meanwhile, many large developers will be trying to reorganise … and major interruptions in financing developers will be resolved.”
China ended 2021 defending its “common prosperity” tagline, employed during its crackdowns on the tech and property sectors. Li, unwavering in his optimism, explains to anxious investors that the campaign “reflects the vision of the Chinese top leadership and the future of Chinese society”.
“Common prosperity should not be confused with short-term policies,” says Li. “The short-term policies are still to restore economic dynamism and prosperity.”
He adds: “Common prosperity as a long-term vision will be maintained.
However, investors should not be concerned about its short-term implications. In fact, in the near future, there will be policies trying to restore investors’ confidence, which was hampered by the confusion last year that common prosperity will jeopardise investors’ interests.”
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Infographic: CEIC, Morgan Stanley Research
