China – taking stock

The themes for the Chinese cycle are unchanged: a clear economic recovery out of the lockdowns; not yet a huge amount of policy stimulus to suggest the recovery can gain real momentum; an ongoing commitment to zero covid that even without further lockdowns will continue to weigh on consumer confidence; and related to that, a lack of underlying inflationary pressure.

Until these underlying themes change, equities perhaps have more upside still, but rates are likely to remain range bound. Interest rate differentials should continue to pressure $CNY higher, though just how far US rates come down will be important in determining momentum in that particular trade.

One risk in all this is policy, and when and if that changes. In terms of zero covid, there's really no sign of a shift, despite the cutting of quarantine requirements from three weeks to ten days. Regional governments continue to impose quite widespread restrictions on activity as new covid cases are discovered. As for the central government, top leaders continue to double down on their commitment to zero covid. That isn't so e surprising, given the huge shock they've so recently been willing to inflict on the economy (and perhaps on their own political capital). But it is important that they are not offering any off-ramp. A good illustration was last week's comments made by Xi Jinping on an inspection trip to the central city of Wuhan:

If China had adopted the ‘herd immunity’ policy or a hands-off approach, given its large population, the country would have faced unimaginable consequences,.... Even if there are some temporary impacts on the economy, we will not put people's lives and health in harm's way, and we must protect the elderly and the children in particular....If we make an overall evaluation, our COVID-19 response measures are the most economical and effective,’ he said.

Perhaps mentioning the vulnerable is the leadership signalling that the latest outbreak resulted in just a few serious cases, and thus that the population can be reasonably protected if the vaccination rate is high enough. In recent weeks, particularly in Shanghai, some progress seems to have been made in raising the relatively low inoculation rates of the elderly. But if this is an off-ramp, it is a narrow one. Indeed, the disparaging reference to “herd immunity” is quite the opposite from warning the population that they have to prepare to “live with the virus”.

In the same trip to Wuhan, Xi Jinping sounded a bit less ambitious on the economy than he had been the week before. Whereas just a few days earlier he'd called for adoption of “more forceful measures to deliver the economic and social development goals”, last week he only said it was necessary to “strive for a relatively good performance in this year's economic development”.

Some of those more directly responsible for the economy do at least seem to be striving. The National Development Reform Commission has been convening meetings across the country to try to push along big construction projects. But while there continue to be calls for implementation of the State Council's package of 33 recovery measures, the tone around the economy still doesn't feel so urgent.

An illustration of that was last week's quarterly meeting of the PBC's monetary policy committee. Understandably, it did remove the reference of three months ago to China's “leading position worldwide” in epidemic control and economic development. But the main new sentence on the economy was to follow the requirements of “containing the pandemic, stabilizing the economy, and maintaining sound development”.

One of the academic members of the committee, Wang Yiming, has suggested separately that policymakers might need to consider another issue of special government bonds (special because they don't get included in the calculation of the official fiscal deficit). That's exactly how China would usually respond when economic growth is severely challenged. But this time around, there doesn't yet seem to be a consensus on this idea.

In terms of economic stimulus, it could be that officials are hoping that the funds generated by the big acceleration in local government special bond issuance programme will be sufficient. And that really has been speeded up. The initial full year quota for 2022 was CNY3.7trn, but almost all of that has now been used. Issuance reached around CNY1.4trn just in June alone, which was a record for a single month.

In addition, the State Council last week announced CNY300bn in bond issuance by policy banks to finance infrastructure projects. Boosting infrastructure is very much a usual policy lever in China, and contrary to the views of many outside observers, the government in Beijing continues to believe there's still room for further investment, even in roads and railways. In announcing the CNY300bn bond issue, the State Council argued that while China's “achievements in developing transportation are already very notable, the per capita intensity of the infrastructure network is still relatively low”. That being the case, the State Council wants to break ground this year on new transport links, addressing interprovincial bottlenecks, building inland river infrastructure, and improving port capacity.

The idea, according to the official readout of the State Council meeting, is that such construction projects will create jobs. Supporting the labour market is also the aim of the other, probably bigger, initiative of Li Keqiang and the State Council, which is reducing taxes and fees for companies. The premier last week visited the Ministry of Human Resources and Social Security, where he said that in stabilising the economy, an important component is stabilising the labour market via “market entities” – in other words, businesses. Government data released last week show that the number of business registrations has increased a further 3.6% this year, and the Chinese government's official website this week posted yet another article extolling the benefits small companies are receiving from all the cuts that have been made in government fees and taxes.

To be fair, the government does continue to talk about the need to boost consumption. However, overall, there's really very little to suggest any change in the underlying policy bias in China towards favouring companies and investment over households and consumption. That being the case, it remains very unlikely that even if there is the announcement of a new central government special bond issue, that much if any of the money will be used to finance meaningful income support for households. That's important, because apart from a big revival in property, such a shift in government policy is probably one of the few events that could shake up the current themes prevailing in the economy and markets.