“I may be drunk, Miss, but in the morning I will be sober and you will still be ugly” said Winston Churchill. Well, China’s first quarter 2021 GDP growth looked robust on the surface but in fact underlying growth momentum was slowing and this should reduce any risk of monetary tightening that the market fears.
The real tightening risk is regulatory, in my view, with Fintech lending, shadow banking and non-systemic zombie companies in focus for crackdowns.
The PBoC is handling a complicated dual-mandate of de-risking the financial system and preventing any financial accidents while sustaining GDP growth. This backdrop is likely to lead to more upside for Chinese yields and volatility for Chinese stocks in the short-term.
Slowing growth and rising financial stress may eventually prompt the PBoC to ease, albeit still selectively, but that will likely be a story in the second half of this year.
China’s strong 1Q21 GDP growth (18.3%YoY) does not provide a useful guidance for policy and a market outlook because of the base effect. One way to adjust for the distortion is to compare with the 1Q19 data.
On this calculation, 1Q21 GDP only grew by 10.3%, and the growth of the major indictors, including retail sales, fixed-asset investment, freight traffic and real estate investment, were hardly robust, except construction perhaps.
The 1Q21 data shows two things. First, China has yet to correct its lopsided recovery problem where the consumption/demand side of the economy is still lagging the growth of the production side.
Second, given the robust headline growth in 1Q21, the low 6.0%+ GDP growth target for this year implies that Beijing would have more policy leeway to pursue its financial de-risking policy.
This quarter is likely to see the peak for China’s economic recovery. The underlying growth momentum is slowing, with exports likely contributing less to GDP growth in the coming months and sequential growth of fixed-asset investment falling.
Consumption recovery will be sluggish as confidence has been hurt by the reform and deleveraging policy uncertainty, which translates into a macroeconomic credit constraint and job and income insecurity. The GDP growth trajectory is projected to slide towards 6.0% in 4Q21.
The true tightening risk this year is regulatory, as I have been arguing. Shadow banking, including fintech lending, will bear the brunt of the pressure as well as weak borrowers that are not systemic.
Meanwhile, the PBoC’s cautious policy stance, which is meant to facilitate Beijing’s deleveraging efforts, is going to create a negative credit impulse (ie, the ratio of new credit flows to nominal GDP) for the system in the coming months. This will aggravate the financial stress stemming from rising defaults in the short-term.
The rise in the share of state-owned-enterprises (SoE) defaults shows Beijing’s retreat from its implicit policy distortion. While this is structurally positive for Chinese assets and credit pricing, the move will hurt market confidence before the public comes to terms with the new normal of less, or no, government guarantee.
The recent concern about Huarong’s potential default may intensify the financial stress in the short-term.
The PBoC has two broad macro indicators for conducting its policy. First, keeping M2 growth at the same rate as nominal GDP growth and, second, keeping the amount of new bank lending the same as last year’s.
Data shows that there is no reason for it to ease policy, ceteris paribus, as these indicators are already above their corresponding targets. M2 growth was at 10.1%, compared to 6.8% of nominal GDP growth at the end of 2020. New bank loans have been rising at an annual rate of 16%. If they do not slow down, new bank loans will overshoot last year’s level, violating the PBoC’s guideline.
Hence, the PBoC is keeping a tight monetary bias amid its broad neutral policy stance (of not changing the interest rate). This is because it has a dual-mandate to facilitate Beijing’s financial de-risking efforts, which includes deleveraging as well as forcing the zombie companies to exit the system, and to prevent any credit events from getting out of hand.
The tight policy bias is meant to carry out the first part of the dual-mandate while the broadly neutral policy stance is meant to ensure enough liquidity for keeping economic growth and the credit system functioning. It is a fine policy balance the PBoC is trying to strike.
A combination of slowing GDP growth momentum (not below 6.0%), rising financial stress (reflected by rising defaults) and a falling credit impulse implies more upside for Chinese yields and volatility for Chinese stocks in the short-term.
However, these set of negative factors could prompt the PBoC to do more selective easing eventually. That will be market positive, but it will likely be the story for the second half of this year.
- Chi Lo is Senior Economist at BNP Paribas Asset Management