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China looks set to loosen the purse strings again

But it may not be to the degree most Western investors expect


David Burrows

The growing likelihood of significant fiscal stimulus in China is one of the main reasons for a constructive view on growth prospects, according to Maarten-Jan Bakkum, senior emerging market strategist at NN Investment Partners.

To put into context, Bakkum explains that in response to the fast economic activity normalisation since March 2020, the Chinese authorities moved rather quickly in withdrawing the pandemic-related stimulus.

This led to a faster-than-anticipated fiscal tightening in the last quarter of 2020, when stimulus reached its peak. As a result, China’s broad fiscal deficit declined from 8.5% to 5.5% of GDP in the first half of 2021.

Fast forward to July, and the Chinese government expressed its first concerns about the impact of the tightening on growth momentum. Investment growth in particular had started to slow, which combined with expectations of peaking global trade, was the reason the government moved explicitly to a policy easing bias.

Policy easing

This change in bias was evident in the reserve requirement ratio (RRR) cut announced in early July.

“Since then, several official statements have reflected a broadening easing effort,” Bakkum says. “Three observations are key here: first, the easing will be mainly on the fiscal side; second, the focus will be on infrastructure investment and reducing the tax burden for the private sector, mainly for small and medium-sized companies; and third, the modest monetary easing that we can expect will probably be targeted rather than broad-based.”

He adds: “Broad credit growth in China reached 7.4% in July, about the same as our expectation for nominal GDP growth in the third quarter. So, there is currently no significant leverage growth, nor should we expect credit growth to move much higher than nominal GDP growth in the coming quarters.”

Only in the event of a new external shock to Chinese growth, Bakkum suggests, will leverage growth be allowed to be clearly positive again, as seen in the first two quarters of 2020.

“The strong focus on reducing and containing financial system risks is why the central government is avoiding leverage growth and managing the fiscal stimulus. Local governments are no longer in the lead, as they were in 2008-2009, when excessive risk-taking via non-transparent local-government financing schemes led to a sharp rise in non-performing loans. Now, financing will be primarily via the issuance of regular central government bonds.”

Increased issuance

From this month, Bakkum expects issuance to rise substantially, given the underutilised quota of government bonds in the first seven months of the year. As a result, he believes construction and fixed-asset investment growth should start to rise as early as the fourth quarter. This should be a positive factor for Chinese commodity imports and might give another boost to commodity prices, primarily in industrial metals.

Tancredi Cordero, chief executive of Kuros Associates, sees things slightly differently to Bakkum, Cordero thinks the Chinese government will certainly increase its debt issuance programmes but not to the degree that most Western investors expect.

“China has always tried to find the right balance between being perceived as a mature superpower and the fact that the Communist Party doesn’t want to show strategic weak spots by having too much of its national debt in the hands of foreign investors, particularly American ones.”

He adds: “Commodity prices are already quite high due to the engulfment of global supply chain, which has been flooded by industrial demand to the point of creating a bottleneck effect just as covid restrictions were starting to lift. I believe some commodities like precious metals and semiconductor metals (eg copper) may still have room to rise, but most industrial commodities might be already toppish.”

Alessia Berardi, head of EM macro and research strategy at Amundi, says that following the disappointing string of data in July, the policy mix is turning definitely more dovish. However, she suggests we’ll see on-budget fiscal spending picking up through Local Government Bonds monthly issuances increases (likely in Aug/Sep/Dec); while off-budget debt (local government funding vehicles LGFVs) tightening continuing.

“Even in a more dovish policy stance environment, easing will be targeted. On the Monetary Policy side, the People’s Bank of China should maintain an accommodative liquidity stance, without rate cut, one additional RRR cut is likely to be announced in late Oct/early Nov, given the Medium-term Lending Facility (MLF) maturing schedule.”

She adds: “With that said, Chinese demand will play a slightly smaller role in boosting commodity prices. The Chinese economy is not expected to resume growth rates similar to the ones pre-pandemic.”

Restrictions in place

The Chinese government’s zero-tolerance approach to the pandemic probably means that some form of travel restrictions will remain in place in the short term. This, Bakkum suggests, will likely keep some pressure on consumer services expenditure, which was already clearly visible in the July data.

“If anything, this increases the urgency of new public investments to prevent a large drop in overall domestic demand. All in all, the case for meaningful fiscal easing in China has become stronger in the past months.”

Other factors, in addition to China, encourage NN IP to remain optimistic about the prospects for growth. These include excess savings, pent-up demand, and tight labour markets in the US and Europe which should sustain consumer demand. Business confidence and strong corporate balance sheets should help boost fixed investment growth. Bank lending surveys show a strong pick-up in credit supply and demand; and policymakers in developed markets are unlikely to reduce economic stimulus much in the coming quarters.

These factors -in addition to the China fiscal policy outlined above- are, according to Bakkum, likely to keep global growth above-trend in the coming quarters.

“The spread of the Delta variant and supply bottlenecks are the main risks and need to be watched closely, but the recent acceleration in the vaccination roll-out should prevent new mobility restrictions in most countries.”

He adds: “And the combination of new investments and higher prices should help supply and demand to find new equilibrium levels in global goods trade and transportation.”

Berardi at Amundi believes other factors -outside of China- will increasingly drive growth over the coming years.

“China remains one of the global demand structural drivers; however, the fiscal effort planned and put in place in the developed markets (namely US and EU) is the one moving the growth premium between EM and DM in favour of the latter.”

She adds: “The next US Infra plan, although spread on a multiple-year horizon, will benefit global demand dynamics as well as commodity prices. The global transition towards greenfield infrastructures (a must in many new fiscal plans) will keep high the demand for certain metals.”