Are China’s economic prospects shifting?

Data published today by China’s National Bureau of Statistics (NBS) show that the annual rate of GDP growth slowed from a record 18.3% year-on-year (y/y) in the first quarter to 7.9% in the second quarter. That was a touch below the 8.1% median of forecasts collected by Reuters. 

Official activity data for June, which were published alongside the full national accounts for the second quarter, were a bit better than consensus expectations but still reported a continued slowdown in activity in the month. Growth in industrial production slowed to 8.3% y/y, from 8.8% y/y in May. Meanwhile, fixed asset investment and retail sales eased to 12.6% y/y and 12.1% y/y respectively.

How does this impact the outlook?

Looking ahead, the near-term outlook for manufactured exports is still relatively good as the sector benefits from strong global demand conditions. Recent activity has been hampered to some degree by shortages of intermediate goods such as semiconductors. Indicators such as the Caixin Manufacturing PMI show that firms have increasingly been forced to meet demand by running down inventories rather than increasing output. But there should still be a positive knock-on effect to production volumes in the months ahead as shortages ease and firms replenish their stocks.

However, as we noted earlier this year, leading indicators have signalled for some time that other parts of China’s economy will experience a cyclical slowdown in the second half of this year as the withdrawal of policy support weighs on activity.

Manufacturing investment actually improved a touch as firms have run into bottlenecks, however there was a continued decline in construction-related investment. Having previously ramped-up borrowing through the issuance of bonds, local governments have tightened their belts in recent months and this is weighing on infrastructure investment. A clamp-down on lending for activity in the real estate sector is also beginning to bite.

Has the lacklustre consumer recovery given policymakers pause for thought?

Meanwhile, the surprisingly tepid recovery in consumer activity, which had been expected to cushion the slowdown in other areas of the economy, looks set to continue. The rapid roll-out of vaccines should help support service sector activity, although the successful containment of Covid suggests that any benefit is likely to be fairly marginal.

The bigger picture is that, while difficult to gauge, there does not appear to have been a particularly strong recovery in the labour market and this has dampened consumer demand. The employment components of the various PMI surveys have never reported a strong rebound, while the flow of migrant labour has so far remained below its pre-pandemic trend.

The relatively sluggish consumer recovery at a time when other sectors of the economy are slowing appears to have caused some consternation amongst policymakers. They surprised the market last week by announcing that the reserve requirement ratio (RRR) would be cut by 50bps for all banks from today.

The RRR cut in itself is unlikely to reverse the direction of travel in economic activity in the months ahead. At best, the 1 trillion yuan (equivalent to around 1% of GDP) that is expected to be released into the financial system is likely to have a marginal impact on lending and market interest rates. However, the shift in policy stance was significant and implies that more easing measures could follow if, as we expect, incoming activity data soften in the months ahead. Meanwhile, banking regulators have also begun to flag risks around a rise in non-performing loans.

A bumper stimulus is not on the cards

A bumper stimulus package is unlikely at this stage – growth will probably have to slow much more for that to happen. But we would not be surprised to see additional RRR cuts delivered in the months ahead and expectations for more dovish policy support could support a further rally in bond market, where yields have fallen fairly sharply in the past week.