Economic activity plummeted at the start of the year owing to the coronavirus (Covid-19) outbreak, with retail sales, urban fixed-in...

Economic Outlook Worsens For China

Economic activity plummeted at the start of the year owing to the coronavirus (Covid-19) outbreak, with retail sales, urban fixed-investment and industrial production all plunging at the sharpest pace in at least three decades in January–February. Consequently, authorities will likely trim the GDP growth target for this year to around 5% from the around 6% target agreed at a top meeting in December. Meanwhile, although the pandemic is slowly receding in China, with new infections dropping significantly in recent weeks due to the government’s aggressive response, risks loom on the horizon: The infection is now hitting key trading partners, consumption remains subdued and there are increasing fears of a second wave of infections. Although monetary and fiscal stimulus have been modest so far, Chinese officials suggested that the government could unveil a massive program in the coming weeks.

GDP is set to post the worst performance in decades in the first quarter due to the coronavirus outbreak. Although many analysts predict a V-shaped recovery, with growth returning in annual terms in Q2, this year China will likely log its weakest growth rate since 1990. Further down the road, government stimulus and a gradual return to normalcy should spur economic activity. FocusEconomics panelists see the economy growing 3.8% in 2020, which is down 1.8 percentage points from last month’s forecast, before decelerating to 6.7% in 2021.

Inflation decelerated from 5.4% in January to 5.2% in February, with core inflation falling to a near one-decade low. The moderation mostly reflected Covid-19 hammering domestic demand. Looking forward, inflation will moderate further as the impact of the swine fever on meat prices subsides and the economy feels the impact of restrained demand due to the virus outbreak. FocusEconomics panelists forecast that inflation will average 3.3% in 2020, which is up 0.1 percentage points from last month’s estimate, and 2.3% in 2021. • The People’s Bank of China (PBOC) continued to ease its monetary policy in order to support the economy. On 13 March, the PBOC slashed the reserve requirement ratio for commercial lenders. The Bank also offered CNY 100 billion via its one-year medium-term lending facility on 16 March but left the rate unchanged at 3.15%. Panelists project the one year deposit and loan prime rates to close 2020 at 1.43% and 3.78%, respectively, and 2021 at 1.60% and 3.75%.

Despite progress in the containment of the coronavirus and signs that companies are slowly getting back to work, an uncertain economic situation continues to weigh on the yuan. On 20 March, the yuan traded at 7.10 CNY per USD, depreciating 1.0% month-on-month. The yuan is expected to remain at around current levels further down the road. Our panelists see the yuan ending 2020 at 7.02 CNY per USD and 2021 at 6.99 CNY per USD.

China to unveil further policy stimulus to rekindle economic growth The coronavirus outbreak decimated economic activity in China at the start of the year, with most indicators recording record lows in January–February. However, boding well for the economy ahead, the health situation has significantly improved since, after the Chinese authorities locked down 60 million people in Hubei province and imposed outdoor restrictions across most of the country. In fact, in recent days the new confirmed cases in China were mostly imported from overseas, according to the country’s National Health Commission. Nevertheless, the new cases are mostly from Chinese expatriates returning to the country as the pandemic spreads across Europe and the United States, which has sparked fears of a second wave. The policy response has been rather moderated to date compared to that implemented in the wake of the Global Financial Crisis in 2008. The People’s Bank of China cut some key policy rates in mid-February, while it also reduced the reserve requirement ratio for selected banks on 13 March. 

In this regard, analysts expect that the PBOC will likely ease its monetary policy. Iris Pang, Greater China economist at ING, noted that her baseline scenario includes: “A deferred rate cut of 10bps in April (we expected it in March) as a targeted RRR cut suppressed interbank rates, which will reduce banks’ interest expense if they lend out more inclusive finance. Further targeted RRR cuts in April or May are possible if global demand continues to weaken.” Meanwhile, Ting Lu, Lisheng Wang and Jing Wang, economists at Nomura, stated: “We expect more financial relief and monetary/credit easing measures in coming months, including further liquidity injections through channels such as the MLF, TMLF and RRR cuts, more rate cuts, using lending facilities such as PSL to fund loan extensions and reductions in interest payments. With rate cuts across the world, the PBoC has more room to cut rates. Specifically, we expect the PBoC to cut the 1yr benchmark deposit rate and 1yr MLF rate each by 25bp in coming weeks in our base case.” In terms of fiscal policy, the measures adopted included tax reliefs, reduction in VAT for small- and medium-sized enterprises, among others. Collectively, the measures amount to CNY 1.25 trillion (around 1% of GDP). 

That said, further fiscal stimulus could be in the pipeline as suggested by Yi David Wang, head of China economics at Credit Suisse: “On the policy front, we repeat our view that China will likely implement a stimulus package amounting to 2.5-3.5% of nominal GDP. […] We also anticipate more fiscal support for SMEs and households (e.g., unemployment benefits, subsidy for low-income individuals, possibly direct tax rebates).” However, some analysts warn that Chinese authorities have limited policy space. Analysts at Nomura, for example, comment that the stimulus plan is constrained in two ways. “First, COVID-19 represents both a supply and a demand shock, and conventional policy efforts to stimulate demand may not work effectively in such a unique situation. Second, surging debt (including foreign debt), a much lower return on capital, the smaller current account surplus and falling FX reserves (as a consequence of several rounds of massive stimulus over the past two decades) are all factors constraining Beijing’s available policy space.” Panelists expect GDP to expand 3.8% in 2020, which is down 1.8 percentage points from last month’s estimate. In 2021, the panel foresees lower economic growth of 6.7%.

Manufacturing PMI nosedives to all-time low in February due to coronavirus The manufacturing Purchasing Managers’ Index (PMI) published by the National Bureau of Statistics (NBS) and the China Federation of Logistics and Purchasing (CFLP) plummeted from January’s 50.0% to 35.7% in February. The print was well below the 45.0% expected by market analysts. As a result, the index fell well below the 50.0% threshold that separates contraction from expansion in the manufacturing sector, with February’s reading representing the lowest print on record. February’s print reflected much lower readings for all the sub-components, with new orders and production leading the pack. Export orders also slumped significantly. February’s dismal performance reflects the spread of the coronavirus, which has halted operations in large swaths of the country and also disrupted supply chains. Although authorities reported that, as of 25 February, 78.9% of the companies surveyed had returned to work, the manufacturing PMI could remain depressed in March. Yi David Wang, head of China economics at Credit Suisse, added that the main factor to watch is the shortage in labor: “We repeat that the key near term uncertainty facing the Chinese economy is when labor input can be restored to the pre-outbreak norm. The fact that PMIs, trade, FAI, retail sales will eventually display V-shape rebounds is irrelevant at this point. Instead, we need to be wary of the rising probability that the supplyside shock from labor input reduction might trigger a new round of negative demand shock even after the virus is contained. Such a scenario can even lead to an increase to China’s natural rate of unemployment.”

Industrial production nosedives at the start of the year due to Covid-19 outbreak Industrial production plummeted 13.5% year-on-year in the first two months of the year, the sharpest contraction since records began in January 1990. The print contrasted the 6.9% rise in December and was well below the 3.0% contraction that market analysts had expected. On a month-on-month seasonally-adjusted basis, industrial production plunged 26.6% in February, exceeding the 2.8% drop in January. Annual average growth in industrial production, meanwhile, tumbled from 5.7% in December to 4.0% in January-February. Industrial production is expected to remain lackluster in the coming months. 

Against this backdrop, Iris Pang, Greater China economist at ING, comments that: “As China’s coronavirus cases subside, the rest of the world has more confirmed cases, including China’s manufacturing partners in Europe, the rest of Asia and the US. This means supply chains are broken. Equally important, demand from these economies will shrink substantially when people avoid shopping and gathering at restaurants, just like the experience of China during the past two months. This is another severe hit for China’s factories and exporters, as orders should pull back.” FocusEconomics Consensus Forecast participants expect industrial production to rise 3.5% in 2020, which is down 1.5 percentage points from the previous month’s forecast. In 2021, the panel sees industrial production growth at 5.8%.

April 2020 Asia Economics, Focus Economics

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