Unlike in the years following the 2008 Global Financial Crisis (GFC), this time the world is more out of step. The main reason is China and Asia’s ‘zero COVID’ approach, which differs from what has been adopted for the time being in the West. This has meant that the Chinese economy has “led” the US and Europe for 2-4 quarters. As China slows after a strong 2020 and 2021, there will be policy divergences just as the US and Europe gain, in parallel, momentum.
China’s “zero Covid” stance will persist in 2022. Not only because of its experience with the past SARS (Severe Acute Respiratory Syndrome) epidemic of 2002-2004, the Chinese public would not accept a significant number of deaths: adjusting for population, if China had half the mortality rates of the United States, there would be 2 million deaths, an unacceptable outcome. Moreover, the zero-Covid stance has allowed China to concentrate resources on testing and quarantine in localised areas rather than nationwide. Finally, a complacent population that puts health before freedom has meant little social upheaval or resistance, as is often the case in several Western democracies.
China’s zero Covid stance is undoubtedly “tough”, but whether it becomes “fragile” will depend in part on whether the pandemic becomes endemic and whether China gains enough time to be able to take advantage of advances in vaccines and therapeutics.
In any case, economic growth may slow in 2022, possibly to around 5%, below the projected growth rate for the US and only slightly above that of the EU.
Thinking in terms of C (Consumption) + I (Investment) + G (Government Expenditure) + NX (Net Exports), the Chinese economy is likely to be driven by I (Public Investment) and NX. Retail sales and many services could continue to lag, affected by equity and property markets, which are still suffering from the losses and setbacks suffered in 2021. This year, China is likely to increase infrastructure spending to offset weakness in private construction. In addition, financial support from the government will continue to flow directly and indirectly to the population (transfers and fee waivers for public services and cuts in fees for services provided by state-owned enterprises). Finally, exports will remain a strength: as long as the rest of the world’s production struggles to meet local demand, Chinese exports can be expected to fill the gap. We believe that the “zero” quota policy should not significantly limit China’s export capacity.
When thinking about China’s sustainable trend growth rate, it may be helpful to consider that GDP growth rates were 6.9%, 6.7% and 5.9% in 2017, 2018 and 2019. China’s growth was already trending at 5% in the pre-pandemic years. Excluding the volatile 2020-21 period, 5% growth in 2022, especially given the tough regulatory reforms and pressures emanating from the real estate sector, would not seem so alarming or surprising. After all, China’s economy is maturing; as the low-hanging fruit has been picked, China’s incremental growth rate should slow as its income level rises. We do not share the view that China’s economic development has entered a dark period, although there will be serious challenges, just as other economies around the world will also face their own challenges.
Finally, financial policies are likely to be defensive/passive rather than offensive/proactive. Throughout the pandemic, the People’s Bank of China (PBOC) never cut the lending rate, while most other major central banks adopted more aggressive QE. Only in recent months has the PBOC announced very modest reductions in the RRR, MLF and prime rate. We believe that the PBOC is unlikely to repeat the mistake it made after the GFC of fuelling a housing bubble through excessive monetary stimulus. Instead, monetary and fiscal stimulus will be provided on a needs-based basis to maintain employment; there will be no attempt to ignite another growth spurt that cannot be sustained over time.
Against this backdrop, we maintain a favourable outlook for the Chinese bond market in 2022. Growth will slow considerably this year due to an orchestrated effort by Beijing to restrain the property sector and realign the economy to put it on a more sustainable path, both economically and socially. With weak growth and low inflation, nominal GDP growth will slow significantly to push bond yields lower, even if US Treasury yields rise. At the same time, the RMB should continue to enjoy the support of a favourable balance of payments position. In the absence of major economic or political shocks, foreign capital should continue to flow into China’s newly opened bond and equity markets. This configuration should provide a supportive environment for Chinese RMB bonds.
