The July Politburo meeting is important for economic policymaking in China, as it sets the tone for economic policy for the second half of the year. This year’s statement offered a bleak picture of the economy, following a meagre 0.4% year-on-year growth in the second quarter, or -1.8% quarter-on-quarter growth, according to our estimate.
We were of the view the government might use the occasion to announce further infrastructure funding. However, no additional stimulus was announced and for the most part, the statement simply reiterated already-introduced policy easing.
In our August baseline, we still expect a pickup in quarter-on-quarter growth in the second half of the year, reflecting demand driven by existing stimulus, notably via infrastructure spending, and more generally a normalisation of activity after the lockdowns in the second quarter. But with no new stimulus in the second half of the year to offset the weaker-than-expected second quarter outturn, we have reduced our 2022 growth forecast to 3.2%. In other words, our cut mostly reflects the weaker quarter-on-quarter growth in the second quarter, while we keep the quarter-on-quarter outlook largely the same for the third and fourth quarters (Exhibit 1).
Exhibit 1: Growth downgrade amid weak Q2 outturn
Stimulus to boost quantity, not quality, of growth
The Politburo now signals leeway for missing the “around 5.5%” growth target, but policymakers continue to focus on achieving employment and price stability. Now that the government no longer needs to meet its growth target for the year, market speculation of a massive stimulus has been reduced. Indeed, despite dismal second quarter growth, the government has refrained from new stimulus and focused on implementing easing that has already been introduced, including the RMB3.65 trillion ($540.2 billion) local government special bond quota, as well as state-owned policy banks’ lending (RMB800 billion) and infrastructure-bond financing (RMB300 billion), among others.
Slower growth will widen the negative output gap, meaning further underutilisation of capacity. But the bigger issue, in our opinion, is that regardless of whether there is more stimulus or not, the recovery over the next 12 months will be lopsided, which will deepen the economic scarring from COVID.
First, while infrastructure investment will be the main source of demand growth in the second half of the year, it may not have a meaningful spillover effect to the private sector (especially not to the services sector). Additionally, infrastructure spending is not the best policy option to stimulate hiring when labour market weakness is concentrated in the private sector, which accounts for 80% of urban employment. A skills mismatch also means that boosting infrastructure projects won’t absorb those who lost private sector (and often service sector) jobs.
We expect the government to roll out additional funding in the coming months to ensure infrastructure investment will remain robust into the fourth quarter (which is what we assume in our baseline). But while this will help support headline GDP growth, it may not generate additional employment in a meaningful way.
Secondly, as long as the dynamic zero-COVID policy is in place, efforts aimed at stimulating consumption and business investment will likely have limited effect (apart from the strategic industries such as advanced manufacturing, hard tech, and climate-related sectors that will be supported by policy easing and the government’s enthusiasm about industrial upgrading and innovation). Consumer sentiment is unlikely to turn upbeat as the risks of sporadic COVID outbreaks and reimposed restrictions in small neighbourhoods remain high (Exhibit 2). While other policies—such as VAT tax cuts and preferential lending to SMEs—that have been rolled out may help businesses remain afloat, they won’t be enough to stimulate investment as COVID restrictions continue to be a key (and very real) downside risk.
Exhibit 2: Poor consumer sentiment and business conditions
Assuming China drops its dynamic zero-COVID policy in the first half of next year (by ending the reimposition of restrictions, regardless of the name it gives to the policy), we expect the private sector to take up the growth baton and support the 5.1% growth that we anticipate in 2023. But the recovery this time will be different. Barring an initial rebound that is partly real, partly statistical, we think China’s recovery will be relatively limp compared to the past, given that the return on investment has been in secular decline and China has failed to shift to becoming a consumption-led economy.
Real estate remains the biggest medium-term risk
The real estate downturn will likely linger for a couple of years, if not longer. The mortgage boycott by homebuyers is a symptom rather than the cause of the slump. The crux of the problem is that property developers have insufficient cash flows—whether because of debt-servicing costs, low housing sales, or misuse of funds—to continue with projects. Resolving this problem will rebuild homebuyers’ confidence in developers, which will help support housing sales and, in turn, improve developers’ financial health.
We expect additional funding to be arranged to support the completion of unfinished houses. Indeed, the statement from July’s Politburo meeting stresses the need to stabilise the property market and ensure the delivery of houses. We think these efforts are unlikely to come directly from the central government. Instead, authorities will likely ask local governments, banks and property developers to coordinate and ensure that unfinished housing projects are completed.
Developer default remains the biggest risk ahead. It could be years before developers’ financial problems are resolved. Moreover, the authorities will likely keep most of the significant curbs in place, including the “three red lines” policy on developers’ financing. The government remains keen on managing leverage and, perhaps, on reducing the real estate sector’s economic footprint (almost a quarter of GDP in China vs 15% in the US). The latter will free up resources away from real estate towards the strategic high-tech, innovative sectors that have been the emphasis in Beijing’s medium- and long-term economic plans.
But, while containing real estate leverage is beneficial to sustainable (albeit slower), long-term growth, the process will be bumpy and the risk of a hard landing in real estate will continue to haunt the economy for some time.