Investment Strategy

Is China’s growth target achievable?

Mar 10, 2022

Market Strategy

The economic effects of Russia’s invasion of Ukraine are coming into focus. We still see one of the biggest impacts on the global economy coming from disruptions to commodity supplies, with Europe’s exposure to Russian gas giving it substantial downside risk to growth. The backdrop of weaker growth and higher inflation creates a difficult environment for central banks, and measuring the extent of the commodity price shock on growth and sentiment remains a challenge.

Markets continue to face higher volatility as they balance tail risks from further escalation with emerging value in markets that have sold off. Markets are trying to differentiate along these lines, in some cases already pricing in a deep economic downturn. Even small shifts can have large effects on pricing and volatility. On Wednesday, optimism around a “diplomatic solution” to end the conflict sparked a rally in risk assets and a decline in energy prices. We still remain cautious – while some value is starting to be created in certain areas, most expectations envision an extended military conflict, with risks of escalation, and it may therefore be too soon to “buy-the-dip.”

There is risk of further sanctions, from either the West or Russia, which reduces the supply or demand of commodities, creating the chance of further upside to commodity prices, and as we’ve pointed out, it’s not just oil. Higher prices for food, metals and agricultural commodities could create price pressures across the board. As such, we still recommend commodity exposure – particularly after the mid-week pull back – as a hedge against further dislocation and the resulting negative growth impact. Commodities remain an attractive negatively-correlated hedge – and any move higher will likely bring down growth estimates, hurting risk assets. A move lower could prove to be a boost to risk assets. In equities, we like commodity-linked companies, defense companies (on the back of substantially higher expected spending), and healthcare for its defensive properties. Alternatives – both hedge funds and private equity – continue to make sense. Hedge funds can take advantage of higher volatility and real assets provide inflation protection. We think the dollar could see further strength from a flight to safety. 

Strategy question: China announced its growth target of 5.5%, so why is our outlook below consensus at 4.5%?

The annual policy meeting in Beijing announced a real GDP growth target of around 5.5% for 2022. Given the high base in 2021 (8.1% GDP growth), achieving this target will be no small feat. In 2021, GDP growth averaged about 1% quarter-over-quarter, implying an underlying growth momentum of just over 4%. This reflects the impact of Zero-Covid policy on consumption, withdrawal of pandemic-related policy easing, and de-leveraging of the housing sector over the last 12 months. Given this run rate, generating 5.5% growth in 2022 will require growth to increase to a run rate of 6.5% quarter-on-quarter annualized in order to reach this target. This will likely require a significant amount of policy easing, and in our view, some pretty big policy shifts.

In terms of macro policy, policymakers pledged a more proactive fiscal stance. But the details are very nuanced. The official budget targets a smaller deficit as a share of GDP, compared with 2021. The budget only looks marginally expansionary when the reserve deployment is included. In our view, even in the optimistic case that the full amount of fiscal firepower is spent according to the budget, it is not clear how much the additional 0.3ppt of GDP worth of extra spending can do to help growth. In addition, in 2021, both local governments and the central government over-delivered on revenue growth, under-delivered on spending growth as well as under-utilized deployable reserves, suggesting that the fiscal machine is still very conservative in nature. 

To the extent that fiscal and monetary policy easing are quite closely related in China, it’s not immediately clear how much additional ‘boost’ monetary policy can provide in 2022. The overall tone on monetary policy continues to be quite neutral. The PBoC will likely still aim to keep credit growth basically consistent with nominal GDP growth. This is explicitly designed to keep the overall leverage ratio in check, and the monetary policy stance neutral relative to economic growth. In the first two months of the year we have seen some incremental policy easing, but if the Fed goes ahead with interest rate hikes, the PBoC will likely revert to a more cautious stance.

Apart from macro policy, the policy stance on the housing sector will also be consequential from a growth perspective. From peak (Q1 2021) to trough (Q4 2021), the housing sector slowdown shaved 2.2ppt off (nominal) GDP growth last year on its own, without counting the indirect impact on activities such as construction and consumption. As the slowdown gathered pace throughout 2021, by Q4 housing sales were contracting by 20% year-on-year. Aggregation of company-level data implied even bigger contractions in January and February of 2022 (official national sales data will be released on 15th March). Expectations of flat to declining prices, the roll-out of additional property taxes, and defaults by large, well-known developers continue to weigh on buyers’ sentiment. Reversing the housing downturn is one of the easiest ways to engineer a growth rebound. But given that a lot of long-term structural policies are involved – and with ‘common prosperity’ at stake – such reversals cannot be taken for granted.

All in all, the policy targets certainly struck an optimistic tone. But the gap between the current situation and the targets looks large. There also doesn’t appear to be material easing or major policy shifts in the pipeline, so we’re inclined to keep our current GDP assumption of 4.5%.

Equity implications – Positive for consumption, neutral for property

While there is no massive stimulus, targeted loosening will benefit certain sectors in the medium term. Generally speaking, consumption sectors geared towards the mass market and common prosperity should get an earnings boost, while overall A-share markets will likely also benefit from better liquidity.

First of all, a RMB2.5trn tax cut and rebate (up from RMB 1.1 trn last year) will benefit small-to-medium-sized enterprises (SMEs) and strategically important sectors, which will likely indirectly boost consumption sentiment. A new structural tax cut will also be rolled out to alleviate the pressures of SMEs and the self-employed. These tax cuts will likely be particularly favorable to service sectors hard-hit by the pandemic, such as online travel agents, hotels, retail, airlines and logistics. With the world likely to declare the pandemic over at some point in 2022 we think China will be increasingly pressured to revise its “dynamic zero Covid” approach. But as seen in Hong Kong the path out of the pandemic for a population with no natural immunity and a low rate of elderly vaccinations is not easy. Once this process starts we would be buyers of re-opening plays on dips.

Consumer sectors (e.g. diary and baby products) targeted at newborns will also benefit, as new tax credits are being offered to young children (< 3 years old). A new policy focused on bringing smart home appliances to rural areas should see white goods and consumer electronics producers gaining higher growth visibility in the next one to two years. Not surprisingly, electric vehicles continue to receive policy support, and a new member to the alternative car space may be arriving – the methanol-fueled vehicle.  

Last but not least, the principle of “homes are for living-in, not for speculation” remains unchanged, smashing hopes of a massive loosening in the property sector. Meanwhile, property tax isn’t being mentioned, and a shift towards a higher mix of long-rentals in cities is being encouraged. Hence, we do not see a significant change in policy direction. Loosening in the property sector should continue, but remains highly selective, and probably more focused on the demand side (i.e. cutting mortgage rates, removing first-home purchase restrictions etc.) rather than on the supply side (i.e. the Three Red Lines of the developers). This supports our relatively cautious view on the China property sector at least for Q2 2022. 

All market and economic data as of March 10, 2022 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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