Outlook For China’s Growth Remains Weak

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Éric Morin, M.sc

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My name is Eric Morin. I’m a Senior Analyst at CIBC Asset Management.

So what’s our Chinese outlook for the next 12 months? Well, we have an outlook that is below consensus. In fact, we’ve been below consensus in China for about a year. We’ve been bearish for about a year, and we remain bearish for several reasons.

The first one is the virus itself. It should remain an important growth impediment in China. While it’s likely that China may eventually abandon its zero-Covid policy after the Party Congress of the Communist Party next fall, the country is in a vulnerable position due to the lower efficacy of Chinese vaccine, due to a near zero rate of natural immunity from past infection, and also due to a low vaccination rate among the senior citizen. So living with the virus would result in weakness for services, or would at least cap demand for services.

So this is some sort of a lingering headwind for China. And itself, it’s problematic, but it’s more problematic because consumption fundamentals prior to the arrival of Omicron were already weak in China. And looking ahead, we think we consider that Omicron, with lackluster growth prospect, will result in weaker consumption fundamentals for the consumer in China. So this is of course not positive for the growth outlook.

The third aspect is related to foreign demand. Since the start of the pandemic, China’s external demand has been exceptionally strong, supported by large-scale stimulus made by developed markets. And this has been a key tailwind for the Chinese economy. However, looking ahead, we’ll have some sort of a reversal of that tailwind, which will become a headwind. With developed markets central banks hiking, the strength of external demand should recede. And this will become mechanically negative for the Chinese economy.

The fourth concern is related to housing. One of the reasons why we’ve been bearish China is because of housing. And historically housing has been a key driver of growth in China, along with infrastructure. The problem is that policymakers don’t want to engineer growth… housing-led recovery, because China has an oversupply of housing units outside large cities. And also, China is experiencing an increasing pace of decline of its working-age population. So this is problematic, and we have to keep in mind that the median age in China will soon reach 40 years. And when we look at the long-term outlook for housing, we see less prospects for internal migration of workers to urban centers, which has been historically a key driver of housing demand. So the point there is that policymakers in China don’t have the appetite to generate a housing-led recovery. So we don’t have this sector as a candidate to explain why growth could be strong.

The other reason why we have a below-consensus outlook is because we don’t expect large-scale stimulus to be implemented in China. And this is an important point, because historically since 2007, 2008, China has launched four large-scale infrastructure stimulus, which eventually boosted global growth. We think that there are true reasons why policymakers will not launch a big infrastructure stimulus. The first one is there are fiscal limits. China has limited fiscal leeway to launch a large-scale stimulus. So when we look at the augmented deficit, which takes into account the deficit of the central government, local government, state-owned enterprise, and local governments’ financing vehicle, the deficit was about 15% of GDP prior to Omicron. And with Omicron, this deficit number has likely reached 20%.

So there is some sort of a fiscal limit there, that will contribute to limiting the magnitude of the stimulus. The second reason and the third reason are intertwined. It’s that financial stability costs have increased by doing infrastructure stimulus, and also there are operational constraints. So as I said before, China has launched four large-scale stimulus in more than 10 years. And the country has run out of low-hanging fruit options regarding the selection of infrastructure project that are both profitable and easy to implement quickly. So think of, let’s say, highways or high-speed trains. The risk is that a large scale stimulus at this juncture would more likely include project that are not profitable, which could cause a risk to financial stability down the road. After the 2020 stimulus… So in 2020, China did an infrastructure stimulus. China decided to cancel some infrastructure project for that reason, of low profitability.

And the last reason… So the fourth reason why we don’t expect a large-scale stimulus, is that every time there is a large-scale stimulus, subsequently there is a big payback that is negative on growth. And China has no appetite for that. And it’s for that reason that the 2020 stimulus was modest in size, compared to previous rounds of stimulus. So the bottom line there is that we expect a stimulus of 1-1.5% of GDP, a stimulus targeting infrastructure.

That’s positive, but that’s not spectacular. And this is not a stimulus that is likely to boost global growth in a meaningful manner. In terms of composition, well, one of the question is what are the implication from a multi-asset perspective, and which sectors or industries should benefit the most in this outlook? Well, we consider that the stimulus in China will be targeting decarbonization investment. So this includes solar panel, for example. This includes smart electricity grid, acceleration of the implementation of the charging station for electric vehicle, for example.

And this is likely to result in winners. So the industries that are likely to benefit from that stimulus are, as I said, solar panel, smart electricity grid, etc. And in terms of commodities, this is positive for copper, unlike for other cyclical metals. So this is the bucket of winners. On the other hand, there will be losers. Industries that will underperform. And we have in mind industries that are targeting consumer discretionary spending in China, including luxury brands. This industry is likely to underperform. But globally, if we go back to the big picture, the Chinese outlook is not compatible with a strong acceleration of growth in 2023.