China’s economic recovery is going strong, despite a slight hiccup

The Chinese economy was hit by renewed coronavirus outbreaks before the Lunar New Year, but the effects were uneven and rather short-lived
There are plenty of reasons to be optimistic about China’s economic outlook. Mobility is returning to levels seen in 2019, and China has started a vaccine drive

Aidan Yao

Published: 2:30pm, 24 Mar 2021

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China’s economy started 2021 on an uneven footing. In the first two months, the supply-side recovery continued, with industrial and manufacturing production gaining further steam thanks to strong external demand and less Lunar New Year holiday disruption because of this year’s “stay put” policy.

In contrast, retail sales and investment, outside real estate, were hit by an unusually cold winter and tighter mobility restrictions following a resurgence in Covid-19 cases before the Lunar New Year. The recovery in domestic demand was therefore halted, although the effects appear to have been rather short-lived.

A combination of a subsiding pandemic, accelerated vaccination, a faster recovery of global demand and a slower exit of fiscal stimulus suggests growth in 2021 may be better than we forecast.

Apart from the usual seasonal patterns, interpretation of this year’s economic data has been made more difficult by the economic fallout from Covid-19. Although major activity indicators skyrocketed year on year in January and February, it was really a reflection of the devastating shock from the pandemic last year.

A simple comparison shows that industrial production (up 35 per cent year on year) and retail sales (up 34 per cent year on year) beat market expectations, while investment fell short of forecasts, but still grew by 35 per cent.

One way to remove such distortions is to calculate the two-year compound annual growth rate by comparing data for January-February 2021 with that for the same period in 2019. By this measure, industrial production growth accelerated to 8.1 per cent in early 2021 from 7.3 per cent in December, indicating little impact from the new coronavirus outbreak. In fact, strong export orders and less leave taken by migrant workers have boosted production in recent months.

In contrast to the buoyant industrial output, both retail sales and investment growth weakened relative to the end of 2020. The former reflected tighter social restrictions limiting travel and spending during the Lunar New Year holiday.

Seasonally adjusted data showed that retail sales were the weakest in January, contracting 1.4 per cent month on month, although half of that loss was recouped in February.

The weakness in investment was concentrated in infrastructure and manufacturing, while property investment was supported by solid house sales.

Overall, the picture seems clear: the Chinese economy was hit by the resurgence of Covid-19 cases, but the effects were uneven and rather short-lived.

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Looking ahead, there are plenty of reasons to be optimistic about China’s economic outlook. Domestically, the subsiding number of coronavirus cases has allowed the economy and society to normalise, with mobility returning to 2019 levels.

China has also started a vaccination campaign for the general public: more than 50 million doses had been administered by late February, with Beijing aiming to inoculate 40 per cent of the 1.4 billion population by the end of June.

This should help put industries that have struggled so far – such as tourism and accommodation – on a faster track to normalisation.

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Externally, exports have gone from strength to strength, surging by a whopping 61 per cent year on year in the first two months.

While our 2021 forecast already assumed a strong and synchronised global recovery, more expansionary fiscal policy in the United States could turn a good year into a great year for exporters serving that market. No wonder manufacturing production has held up well in China, with business expectations at a multi-year high.

Last but not least, a slower-than-expected end to the fiscal stimulus could reinforce growth expectations. China’s 2021 budget, announced at the National People’s Congress, implies a more accommodative fiscal stance than previously envisaged, given the large official deficit and special bond quota earmarked for local governments.

Monetary policy, on the other hand, can afford to be less lenient as the financial authorities stay guarded against downside risks. Recent liquidity operations of the People’s Bank of China seem to support this view, but these have yet to be reflected in credit growth, which remained strong at the start of 2021.

The “no sharp turn” policy stance was reiterated during the NPC, although targeted tightening of specific sectors, such as the property market, could be stepped up as financial risks build. I continue to believe any hike in interest rates or bank reserve requirement ratios will be unlikely this year, despite the modest upside risks to the growth forecast.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers