The comeback in the fourth quarter is yet to be played
The Chinese economy may have already bottomed out in the second quarter of 2022, but the road to recovery has not been smooth. The summer heat wave led to electricity rationing in several major cities such as Chengdu and Chongqing, a booming economic area with 50 million inhabitants. Meanwhile, retail sales, an indicator of overall consumption, have maintained their steady pace of growth, while August auto sales were a pleasant surprise (car sales posted 28.9% yoy growth). This has reinforced our longstanding claim that Chinese consumers’ resilience is often underestimated. As supply chain disruptions were eased as Shanghai reopened after a lockdown that lasted more than 60 days between March and June, China’s export boom was further supported by both price effects (global inflation) and improved logistics. Such price effects were particularly evident in China’s rising exports to certain economies (e.g. exports to India grew by more than 50% yoy in both June and July).
Meanwhile, the recovery faces three noticeable headwinds – 1) a struggling real estate sector; 2) financial stress caused by the global tightening that has recently gained momentum; 3) the draconian zero Covid policy.
Chart 1: Real estate investments have been shrinking since September 2021
Source: Wind, Deloitte Research
Chart 2: Pressure on completion property construction
Source: Wind, Deloitte Research
The real estate sector data for August effectively extended the weak trends of the previous months, which started in September 2021. Plunging home sales and investment levels have added to bearish sentiment in offshore markets, where bond yields from major developers like Country Garden and Greentown are around 30%. or 10%. Taken together, data on investments, land auctions and home sales suggest that weaknesses in the housing market are likely to persist beyond the short term, meaning the housing sector is likely to be a drag on overall growth for the next several years. In the short term, the policy goal is to get developers to complete their projects and prevent the mortgage boycott from spreading further. A RMB 200 billion relief fund was set up in late August with a stated mandate to complete uncompleted projects, but markets appear to have doubted its effectiveness. We believe the government will not back away from its current stance that “houses are for living, not speculation” but the reality is that local governments can only reduce their reliance on land sales in the medium term. Therefore, even without strong stimulus to support the real estate sector, the ultimate goal of the policy mix must be to prevent consumers from increasing their savings rate. Ideally, mortgage rates could be reduced while developers would be given incentives to complete their projects. For most Chinese consumers, they view property as both a consumption and an investment. Banks will therefore have to sacrifice some profits by lowering interest rates to offer more candy to future homeowners. The question is to what extent commercial banks could lower the cost of capital against the backdrop of global monetary tightening. In our view, the PBOC could persuade banks to cut mortgage rates further, say to 100 basis points, but ultimately meaningful monetary easing could only be implemented if the exchange rate were more flexible. Due to the recent development, major banks cut deposit rates by 10 to 15 basis points on Sept. 15, a preemptive measure to lower lending rates. China’s favorable balance of payments and relatively benign inflation allow the PBOC to deviate from the Fed’s tightening, but the external environment plays a role. The message from Jackson Hole, where central bankers meet every year, was unambitious – big central banks like the Fed and ECB must continue their tightening crusade, even if it means the real economy could suffer. The ECB’s latest move to raise interest rates by 75 basis points, announced on September 8th, has confirmed this policy bias. The euro has received a rare respite from the ECB’s hawkish signal and has surged above parity against the greenback, but an overwhelmingly bullish sentiment on the USD remains intact as another yen decline shows (USD/JPY has risen above 142, another 25-year high). If the dollar remains strong on the back of the Fed’s tightening campaign and the current issues in some emerging markets, more central banks will need to step up their monetary tightening efforts.
This is the case in Asia, where most central banks will have to hike interest rates twice in the remainder of 2022. Again, the region’s two largest economies, China and Japan, need to reflate their economies for different reasons. For Japan, a weaker yen does not hurt as long as domestic inflation is contained. Unlike 25 years ago, China is the largest trading partner for most regional economies, and a rapidly depreciating yen has had relatively little impact on regional currencies. The PBOC’s decision to take USD/CNY near 7.0, a psychological threshold, surprised the market but not us. Our USD/CNY forecast for 2022 above 6.9 earlier in the year was based on China’s need to improve monetary policy effectiveness, not competitiveness. The question is whether China should more sensibly adjust its exchange rate in line with the competitive devaluation policies of other central banks (e.g. Korea). For stability reasons, we believe it is unlikely that the PBOC will adopt the BOJ’s reflation strategy. Meanwhile, rising interest rates around the world may cause risky assets to underperform in most emerging markets until US interest rates peak. The next FOMC meeting will be a tough test as investors remain unconvinced that the Fed’s sharp rate hikes could easily halt stubborn inflation.
The final challenge is Covid. Based on the latest mobility data (passenger flows during the Mid-Autumn Festival shrank by 37.7% yoy), travel-related sectors have taken an extra hit as partial lockdowns were imposed in many cities. Dynamic zero-Covid policy has made a Q3 recovery more anemic than previously anticipated, but it will always be possible to further tweak current policy as we learn how to better manage the virus. Assuming lockdown measures become more calibrated in Q4 and the Fed enters the final phase of tightening over the next few months, a Q4 recovery remains on the cards. Therefore, we are sticking with our original 2022 GDP forecast of 3.5% with an asterisk.