China has little choice but stimulus

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Will China be forced to stimulate?

The near universal reaction in the west to China’s refreshed 5 per cent gross domestic product growth target: good luck with that. 

Growth in 2023 — if you believe the data — was 5.2 per cent, and more than two-thirds of that came from a modest consumer bounceback from zero-Covid. Now that tailwind is gone, and consumer confidence remains terrible. New problems are cropping up: local government deleveraging, industrial overcapacity, capital outflows. And current fiscal and monetary stimulus efforts have been halfhearted. “There is little evidence that Beijing has the policies to achieve the growth target it has declared,” the Financial Times editorial board summed up.

The old growth drivers — property, infrastructure and manufacturing — all face major constraints. Property’s structural decline is well known; home prices and sales keep falling. Meanwhile, infrastructure is running into the limit of high debt levels. Chinese officials were dispatched last year to prod local governments to delever. It began with easy cost cuts: withholding wages from civil servants, delaying payments to vendors, slashing city services. But more recently, the deleveraging drive has been hitting infrastructure projects already under way, as Reuters reported in January:

Increasing its efforts to manage $13 trillion in municipal debt, the State Council in recent weeks issued a directive to local governments and state banks to delay or halt construction on projects with less than half the planned investment completed in 12 regions across the country, the sources said.

Also, over the weekend in the FT:

In south-western Yunnan, 1,153 government-funded infrastructure projects such as highways and theme parks have been suspended and new construction halted to limit expenditures and focus on debt resolution, according to a document seen by the Financial Times.

It is hard to see how this doesn’t hold back growth in the near term.

Lastly, manufacturing. Since about 2020, the credit that once flowed to the property sector has been redirected to manufacturing, especially in politically favoured sectors such as solar and electric vehicles. The year-over-year growth rate of loans to Chinese industry has risen steadily, though the level is now declining (see the chart from Clocktower Group below). In contrast, credit growth is decelerating overall, and outright shrinking in the property sector:

This pivot back to manufacturing is “radical”, says Adam Wolfe of Absolute Strategy Research, and it has generated important victories for China. Most notably, BYD is now the world’s biggest EV maker, and China the biggest auto exporter. But it has also created an enormous oversupply of manufactured goods, which, when combined with limp demand at home, is crushing industrial margins and fuelling deflation (Wolfe’s chart):

China could deal with this, as it has in the past, through some combination of state-directed industrial consolidation and higher exports. But China’s manufacturing trade surplus is already huge, perhaps 2 per cent of world GDP. As Gavekal’s Yanmei Xie wrote in the FT last month, western countries sensibly fear China dumping cheap goods into export markets. A cheap renminbi heightens the threat; trade retaliation is widely anticipated. If that is right, export-led growth probably can’t be China’s escape valve.

This glum picture suggests that China may soon be forced into stimulus. Assuming the GDP target is at least somewhat binding, no sector of the Chinese economy stands ready to get growth to 5 per cent. A pick-up in consumption could do it, but we’ve heard no convincing story for why anxious consumers would suddenly become gripped by animal spirits. As Michael Pettis, the well-known China watcher, wrote on Friday:

Although so far Beijing has been extremely reluctant to do so, there seems to be a rising consensus among Chinese economists and economic policy advisers that Beijing should direct fiscal expansion not into boosting the supply side of the economy but rather to funding a one-off increase in household income—perhaps through consumption vouchers—to encourage Chinese households to expand consumption…

If neither [a rise in net exports or sudden rise in consumption] happens [over the next quarter], I would be surprised if Beijing didn’t turn to more direct support for consumption. In that case, we can expect some time in the third quarter, or perhaps by the end of the second quarter, that Beijing will seriously consider the possibility of a fiscal boost—perhaps of as much as RMB 2-3 trillion—directed at delivering income to the household sector.

Even if Beijing chooses to accept below-target growth, ASR’s Wolfe sees China coming up against a more fundamental constraint: the labour market. Leaving aside the chronic issue of high youth unemployment, the official unemployment rate has been stable and alternative private-sector data looks calm enough. But Wolfe argues that could soon change:

So from [Chinese authorities’] view, these are just transition pains to a new growth model. They don’t want to do more stimulus, because they don’t want the economy to revert to the old growth model. They want to see the real estate sector shrink as a share of GDP. And as long as people have jobs, [officials can tell themselves that] things are fine; just quit complaining!

But you could see a continued contraction in real estate this year. Completions are now running well ahead of housing starts, so actual construction work is going to come down soon. If the government also starts to pull in infrastructure spending, then the construction sector is going to start shedding labour at a much faster pace. 

A deteriorating labour market would be “a real constraint on the government’s ability to just muddle through”, likely forcing it to enlarge its stimulus plans, he says.

Where does this leave China-curious global investors? We’ve argued that picking the inflection point in Chinese markets will be very hard, boiling down to a call on opaque Chinese politics. Recent developments illustrate the point. The unclear stimulus outlook has left the bulk of investors nervous, but equity outflows have at least stopped. The stock market has rallied 14 per cent since early February, but only because of ample support from the state. Value trade or value trap?

What keeps us sceptical is the fact that Chinese stocks are not loads cheaper than global stocks. After the rally, the CSI 300 trades at 13x forward earnings, versus 14x for the MSCI all-country world ex-US index. To us the risks in China stocks are much clearer than the reward. (Ethan Wu)

One good read

Amazon’s foray into nuclear energy, from FT inductee Lee Harris.

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