Bright spots for the chinese economy

All signs point to a cyclical improvement in China's economy (Image:

According to David Rees of Schroders, the latest data shows another quarter of slowing growth in China. However, economic activity could improve later this year.

Growth in the Chinese economy slowed to 4% year-on-year in the fourth quarter of 2021, according to David Rees, senior emerging markets economist at Schroders. This is down from 4.9% in the third quarter, he said. Together with falling exports and ongoing problems in the real estate sector, he believes this is likely to weigh on the economy in the short term.

The good news, he said, was that leading indicators appeared to have bottomed out, suggesting cyclical economic improvement in the summer. Meanwhile, the interest rate cut implemented in early February is contributing to the incentive measures being introduced by the authorities, he said. In his view, that should ultimately be good news for markets.

"According to official data, GDP growth slowed from 4.9% in the third quarter to 4% year-on-year in the fourth quarter of last year", according to Rees. The data had been better than expected. The consensus forecast had been for a 3.6% increase, while Rees had expected growth of less than 3%. "Monthly economic data suggest that much of the positive surprise in the fourth quarter came from manufacturing, where growth rose to 4.3% year-on-year in December, helped by robust export growth. That meant China's economy grew 8.1% overall in 2021. Strong base effects had boosted the annual growth rate in the first half of last year", explains the emerging markets expert.

Weak economic development in the short term

David Rees is concerned about a slowdown in the Chinese economy. There are at least three good reasons to believe that economic activity will be subdued in the short term, he said.

First, industrial exports, which had been the main economic driver during the pandemic, were expected to fall. Nominal export growth had remained stable in December, registering a year-on-year increase of 20.9%, only slightly down from November's 22% year-on-year increase. However, the low level of new export orders points to a slowdown in the coming months (see chart). Rees believes falling exports are leading to a depreciation of the renminbi, which appreciated sharply on a trade-weighted basis last year. In this context, it is noteworthy that the possibility of a weaker currency is now being discussed in official government channels, he said.

On the other hand, there are the problems in the real estate sector, which he believes are likely to drag on for a while yet. Despite some minor easing, government policy toward the sector remains restrictive, he said. "And new home sales, which typically precede construction activity by six to nine months, have yet to convincingly stabilize", said the Schroders expert. He expects sales to stabilize soon and even pick up slightly in the course of the year. Further difficulties in the sector, however, pose a clear downside risk to our expectations, in his view.

And last but not least, the Covid 19 waves, which are likely to cause periodic disruptions in economic activity. Due to the government's zero-tolerance policy, restrictions have recently been introduced in Tianjin, according to David Rees. Omikron's greater portability means that more cities are almost certain to be affected in the near future, he said.

Light at the end of the tunnel

However, it is not entirely hopeless. The good news, she says, is that there is light at the end of the tunnel. The credit pulse, which measures credit growth as a share of GDP, and the real M1 money supply, which depicts the value of the most liquid components of the money supply such as currency in circulation and overnight deposits, both rose in December. These indicators historically preceded economic activity by about nine months, suggesting that a cyclical improvement in economic activity would begin to emerge toward the end of the northern hemisphere summer.

Rees expects further gradual rises in both leading indicators in the coming months as a result of greater fiscal and monetary policy support. The People's Bank of China announced in early February that it was raising the interest rate on both its seven-day reverse repo rate and its one-year medium-term credit facility by 10 basis points (bps) each, to 2.1% and. 2.85% lower. "These cuts were followed by a 5 bp cut in the prime rate on one-year loans in December, likely to be followed by another 10 bp cut next week. will follow", according to Rees. He says his baseline forecast is based on cuts totaling 20 bp, which should support the economy along with rising public spending. Accordingly, it forecasts a modest recovery in GDP growth from about 4.7% this year to 5% in 2023.

"Evidence of a turnaround for China's business cycle should eventually support financial markets in mainland China as well as emerging markets. As with economic activity, developments in leading indicators have had a lagged impact on financial markets in the past, so more stumbles can be expected in the future", holds the expert finally.