We recently updated our global growth forecasts, which consisted chiefly of downgrades for major economies. The biggest change to our emerging markets (EM) forecast is our outlook for China, where we revised down our expectations for economic growth. However, this was something of a paper downgrade, as opposed to a major deterioration in underlying conditions, as explained below.
In fact, China is one of the few EM economies able to announce a substantial stimulus package consisting of direct fiscal support. This was demonstrated at the recent National People’s Congress (NPC). But to what extent can stimulus revive China’s growth story?
Why we have downgraded our 2020 China growth forecast
In our last round of forecasts, although we knew that China would have a bad first quarter, we were uncertain whether the GDP data would accurately reflect reality. The smoothed nature of Chinese GDP data is well known, and the kind of drop implied by the loss of working days alone in the first quarter could have been concealed by this tendency in the data.
We tried to convey this at the time through our forecast for our in house activity indicator, which we saw falling by much more than official GDP. In the event, however, first quarter GDP printed a 6.8% year-on-year (y/y) contraction, more in line with our activity indicator than with our expectations for official GDP.
This impacts not just our first quarter numbers, but our expectations for Chinese GDP data going forward, as reflected in the chart above. The authorities seem more willing to allow bad news to be reported, if only because it is unavoidable, and this means our forecast for GDP can incorporate greater volatility. This assumption has been reinforced by the recent dropping of the growth target for 2020.
Consequently, we revise our Chinese growth forecast sharply lower for 2020. In many ways though this is a paper downgrade, bringing our GDP forecast more in line with our forecast for the activity indicator; the situation has not deteriorated quite so drastically over the last quarter.
Does the fiscal response have the potential to surprise?
Our current forecast of 2.2% growth in China this year incorporates a fairly strong fiscal response. In general the global fiscal response has seen a sharp divide between emerging and developed market economies, with the latter far less constrained. China is among only a few EM with capacity to announce material direct fiscal support. This was demonstrated at the recent NPC, a major annual policy meeting.
This year’s NPC was notable in many respects, not least because the government dropped its official growth target for the first time. This had been the subject of some speculation in advance of the meeting; China’s longstanding goal of doubling incomes from their 2010 levels by 2020 would require growth of around 5.6% this year, and after a fall in GDP in the first quarter this seemed unattainable. The government appears to have bowed to the inevitable, and will instead target stable unemployment, seeking to maintain joblessness at the current officially recorded level of 6%.
Growth target or not, this will still require considerable stimulus considering the domestic and global backdrop. In fact, from this unemployment target, and the announcement of a fiscal deficit target of 3.6% for 2020, we can work out an implicit growth target. In nominal terms, this would be a little over 5%, implying real growth of 2 to 3% this year, dependent on inflation.
To achieve this, the NPC laid out several channels of fiscal stimulus. Alongside a planned increase in the fiscal deficit from 2.8% of GDP to over 3.6%, there will be a RMB 1 trillion issuance of central government special bonds, and an increase in local government special bond issuance from RMB 2.15 trillion to 3.75 trillion. This together gives us a headline fiscal stimulus of around 3.6%, but there are additional factors which push the number higher.
First, the fiscal deficit target is very often met by sleight-of-hand accounting tricks, with reserve funds used to prevent larger deficit increases. Analysis from research firm GaveKal indicates that the actual deficit, accounting for the use of these funds, is increasing from 4.9% to 6.1% of GDP, or an increase of 1.2 percentage points rather than 0.8 percentage points.
Second, and more significantly, local government special bonds (LGSBs) may have a larger economic impact than the headline number alone would suggest. In June of last year, the Ministry of Finance (MoF) made a significant change to the law regarding the use of local government bond funds. Local governments had previously been required to fully fund infrastructure projects from bond sale proceeds. The MoF said that instead local governments could now just provide project capital and use bank loans to fill in the remainder. That is, leverage was now permitted.
This was a big change, allowing infrastructure spend to be up to four times larger than the initial bond issuance, conditional on banks proving willing to lend. Regulations concerning this leverage have been relaxed further this year, and so this could prove a source of upside surprise for infrastructure investment.
A related point is the use of local government financing vehicles (LGFVs). Some analysts have pointed out that local governments face fairly tight deficit limits which will force them to redirect LGSB funds to general spending. This is being offset to an extent by support from the centre, and local governments could also see some improvement in revenues as land sales recover – the rebound in property has been particularly dramatic. Another tried and tested way around deficit limits is to shift the burden off the official balance sheet, and local government financing vehicles are a favoured tool in this respect. Easier credit conditions – broad money and credit growth are expected to be notably faster than last year, according to the NPC, and a higher inflation target also chimes with setting easier monetary policy – will support LGFV borrowing as well as land sale revenues.
How the government is turning back to infrastructure to save the economy
The main takeaway from all this is that China is conducting the largest stimulus response in EM, and the reality is likely to surprise positively against a headline number deemed disappointing by some commentators. We have focused on the fiscal and touched only in passing on monetary policy. But the calls for an acceleration of broad money and credit growth, a higher inflation target, and instructions for the People’s Bank of China to develop “new monetary policy tools that can reach the real economy directly” suggest it will be accommodative of the push for growth.
Having established that a sizeable chunk of money is going to be injected into the economy, the next question is where that money will go. Broadly speaking, there seem to be two main areas receiving direct support. Around RMB 2.5 trillion is earmarked for corporate relief, in the form of extending tax and fee cuts for SMEs to the end of 2020, reduced VAT rates and social security contributions. The bulk of the rest of the stimulus – LGSB issuance – will be channelled into infrastructure. As mentioned, the use of leverage should allow this to exceed the headline number, but there is some disagreement amongst analysts on the boost to infrastructure growth. Estimates range from 10% to 20% growth this year, against 3% last year. We would lean towards the higher end of that range.
One area to have received relatively little support is consumption, or the household sector more broadly. The announcements only explicitly referenced about RMB 150billion (or 0.15% of GDP) for households, consisting of employment subsidies and vocational training packages.
This skew in government support is in line with our expectations. In our last forecast update and elsewhere we have noted the problems the pandemic poses to stimulus efforts. It is not just a shock to incomes, to be made whole by government largesse, it is a shock to animal spirits which can not be addressed purely by money.
If consumers are too scared to go shopping, then it will not matter how much cash the government gives them, it will not be spent. To be sure of fiscal stimulus resulting in an actual increase in demand, it is best for the government to spend the cash itself. Infrastructure offers a channel for this, particularly in China. It also offers more potential positive spillovers for the rest of the world than a stimulus package aimed at households or which focused more on tax relief for corporates, with commodity producers the most obvious and immediate beneficiaries.
Adding to the good news for commodity demand, the property sector in China also appears to be making a healthy comeback. Though not the intended recipient of stimulus at the NPC, which reiterated the government line that property is “for living in, not speculating”, an easing of credit conditions always appears to support real estate. Absent any new restrictions on the sector, we see no reason why this time should be any different.
To cut a long story short, we think that the policy mix announced at the NPC should be enough to keep Chinese growth in positive territory and also see some positive spillover effects for the rest of the world. Policymakers may be eager to avoid the impression of engaging in “flood-like stimulus”, but the water level is undeniably rising.