China’s Economic Growth: Recovery Gathers MomentumNatalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategyNovember 30, 2020
China has been a major contributor to global growth, and its economic activity tends to have significant repercussions for the global economy. To understand where the Chinese economy is in its growth cycle, we highlight several key charts below, which may also provide context for the impact of the coronavirus. China-related political and geopolitical headlines are grabbing the most attention lately. However, China remains an important economic bellwether for countries that have started to reopen following the COVID-19 epidemic.
Chinese Economy Health Check: PMIs
Source: Bloomberg. Data as of November 30, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
China’s latest activity gauges sent a strong signal that the recovery remains on track. Both manufacturing and services official Purchasing Managers Indices (PMIs)1exceeded expectations in November, with the former rising to 52.1—the highest since September 2017. As regards services, we had not seen such PMI levels (56.4) since 2013. Details are equally encouraging, and this includes the improving new orders PMI, the import PMI and the new export orders PMI.
China relied on a sizable but targeted stimulus to get out of the COVID recession and resisted “blanket” easing, such as deep benchmark rate cuts. This approach is clearly working, and China is among very few economies that are expected to post positive real GDP growth this year. Stronger services and solid high-frequency data point to a likely growth upside in Q4—and authorities still have policy room, if growth headwinds intensify.
China Headline Inflation, %yoy
Source: Bloomberg, Data as of 10/31/2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only.
China’s recovery momentum notwithstanding, talks about policy tightening are probably premature. First, China’s inflation dropped from 5.4% year-on-year in January to a mere 0.5% in October, and there is a possibility of deflation in the next few months, if food prices continue to normalize. Lower inflation means higher real rates. This may make China’s fixed income products more attractive—a boon considering the country’s recent inclusion in the FTSE-Russell World Government Bond Index (WGBI). However, higher real rates also mean de-facto tightening.
Understanding the Credit Cycle: Non-SOE Borrowing Costs
Source: Wind, UBS. Data as of November 30, 2020. Past performance is no guarantee of future results. Chart is for illustrative purposes only. Spreads are measured relative to average yield of 1, 3, 5, and 10 year bonds issued by the China Development Bank.
As with any economy, central bank policy is very important in China. In this chart, we can see that interest rates for the private sector fluctuate, whereas the interest rates paid by state-owned enterprises (SOEs) are pretty stable. Therefore, to understand the credit cycle, we point your attention to this private sector, or non-SOE, interest rate.
The cost of funding for corporates has been rising for some time now, and they spiked further in November due to concerns about a wave of defaults among SOEs. Allowing companies to default is not necessarily negative, as it helps price discovery and improves transparency. In the case of SOEs, it can also reduce pressure on the government’s fiscal accounts. However, financial stability considerations are also important, especially the “tradeoff” between near-term collateral damage associated with defaults/cross defaults and longer-term dislocations stemming from moral hazard. The central bank’s surprising long-term liquidity injection this morning is a reflection of official concerns about rising funding costs.
DEFINITIONS AND DISCLOSURES
1Purchasing managers index (PMI) is an economic indicator derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction. We believe PMIs are a better indicator of the health of the Chinese economy than the gross domestic product (GDP) number, which is politicized and is a composite in any case. The manufacturing and non-manufacturing, or service, PMIs have been separated in order to understand the different sectors of the economy. These days, we believe the manufacturing PMI is the number to watch for cyclicality.
Please note that Van Eck Securities Corporation (an affiliated broker-dealer of Van Eck Associates Corporation) offer investment products that invest in the asset classes discussed in this commentary.
FTSE World Government Bond Index tracks the performance of fixed-rate, local currency, investment-grade sovereign bonds.
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