China’s new growth target: what does it mean for markets?

The return of the Chinese government’s official growth target, which was set at “above 6%”, has raised more questions than it has answered; it is far below our forecast for GDP to expand by 9% this year.

Growth of about 6% would imply an abrupt tightening of policy this year, which there is so far little sign of. We suspect that growth will be quite a bit stronger and that the authorities are trying to anchor medium-term expectations.

Either way, financial markets have rarely focused on the official growth figures due to concerns about their accuracy, and have instead tended to react more to cyclical indicators such as the credit impulse and monetary aggregates. These remain supportive in the near term but, with signs that they are starting to moderate, some support is likely to fade later this year.

How to interpret the new economic growth target?

The government’s work report on the opening day of the National People’s Congress on Friday brought back the official target for GDP growth, which was set at “above 6%” for 2021. 

Whereas the growth target has historically appeared to be too ambitious, it is quite the opposite this time. The Reuters consensus forecast is 8.4% and our own expectation is even higher at 9%, as reiterated in our recent update.

A quick back-of-the-envelope calculation using the official, seasonally-adjusted, GDP data shows that annual GDP growth of over 6% can be achieved this year with zero sequential quarter-on-quarter growth. As the chart below shows, powerful base effects alone would be enough to raise GDP in annual terms.

Source: NBS, Refinitiv Datastream, 5 March 2021

The upshot is that either the government is planning to aggressively tighten policy and sink the economy, or growth will be much stronger and the authorities are trying to anchor longer term expectations and deter local governments and individuals from getting carried away.

It is hard to believe that the government would actively choose to bring economic growth crashing down, particularly as the Communist Party celebrates its centenary this year. And there is certainly not much evidence of an aggressive tightening of policy in the details of the economic plan.

If anything, targets to reduce the fiscal deficit to only 3.2% of GDP and cut overall government bond issuance by just 2% of GDP (to 6.5% from 8.4% last year) are less austere than had been generally expected.

So unless monetary policy is to be tightened substantially, which has not yet been the case, or the authorities will heavily massage the data, GDP growth is likely to be significantly stronger than 6% this year.

As a result, for the time being we stick to our forecast for growth of around 9%.

What are the implications for financial markets?

What matters for the performance of financial markets and economies in the rest of the world is not China’s official GDP growth but instead changes in the underlying business cycle. In this regard, the credit impulse and growth in real M1 have typically been far more useful indicators.

For example, earnings revisions for the MSCI Emerging Markets Index and the performance of the overall market are closely correlated with growth in China’s real M1 money supply. This lagged relationship suggests that recent upward momentum in earning revisions has further to run.

Source: Refinitiv Datastream, 5 March 2021

Similarly, the credit impulse has historically been a good guide to the performance of exports in China’s key trading partners.

Source: Refinitiv Datastream, 5 March 2021

These leading indicators appear to have reached a peak and are likely to trend down in the months ahead as policy is tightened gradually.

This forms the basis of our view that the cycle in China’s economy will reach an inflexion point in mid-year and GDP growth will slow to around 5.7% in 2022.