‘First-in, first out’ from Covid-19, China returned to growth in the second quarter with GDP growth recovering faster than many forecasters’ expected from -6.8% y/y to 3.2% y/y. Many market commentators are hailing China’s V-shape recovery but it is difficult to assign the recovery just one letter.
Industrial production has bounced back strongly – visually almost a perfect ‘V-shape’ – helped by a recovery in autos and high value-added manufacturing products. Meanwhile, the recovery in demand has lagged supply, particularly in the consumer sector as households remain cautious on spending. The recovery in retail sales, so far, looks like an ‘L’, and weak imports and a lower services PMI in July suggests this is set to continue. Supported by infrastructure and real estate investment, the recovery in fixed asset investment has been stronger. This has been gradual, perhaps closer to a ‘U’ but is still on track to hit the previous trend in the coming months.
On the other hand, the export recovery – capturing the recovery in international demand – has been quite startling, with exports back to the pre-Covid-19 trend. This is promising for wider global trade, though we are wary of extrapolating given second lockdowns around the world and the significant amount of Chinese exports of Covid-19 related medical supplies.
This quarter, we tweak the Chinese growth outlook slightly lower by 0.1% to 2.1%. To an extent, this captures second outbreaks of the virus, both at home and abroad, which should dampen activity somewhat. The weakness in demand relative to supply will likely result in destocking in the second half of the year, acting as a drag on growth. On the positive side, we upgrade next year’s growth outlook to 7%, reflecting the potential for an improved trading relationship between US and China as a result of a Biden presidency (should that be the case).
We still expect inflation to fall this year, but by less than before as a result of higher oil and food prices. Then lower oil prices and a stronger currency lowers our expected path of inflation in 2021. With the economic recovery on track, less disinflationary pressure and concerns surrounding speculative bubbles, the People's Bank of China (PBoC) has slowed the pace of easing. Given the recent guidance, we see less rate cuts than before, with the reserve requirement ratio (RRR) ending the year at 11% and 10% in 2021. On the fiscal side, the authorities retain the option of further fiscal stimulus if the recovery looks in jeopardy.
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