Morgan Stanley: Here Comes The China Upswing
From Chetan Ahya, chief Asia economist at Morgan Stanley
The China Upswing
Over the years, China has experienced a number of mini-cycles. This year brought another iteration – the economy started the year on a strong footing but has entered a policy-induced downturn. The policy cycle has shifted from overtightening to easing, and our chief China economist Robin Xing estimates that GDP growth will accelerate to 5.5%Y in 2022. Investors we speak with are less confident in the recovery, but we think that this mini-cycle repeats a familiar pattern and policy-makers have already taken steps to reverse the downturn.
Moreover, the recent statement after the Central Economic Working Conference confirms their resolve and increases our confidence on the recovery call.
China’s mini economic cycles tend to follow policy cycles. Most downturns begin because of macro or regulatory tightening. Tighter policy starts out as counter- cyclical, typically when external demand is strong. But eventually it becomes pro-cyclical, sometimes because external demand conditions deteriorate (e.g., the onset of trade tensions in mid-2018). Once growth decelerates beyond the policy-makers’ comfort zone, their priorities shift to stabilizing growth and preventing an adverse spillover impact to the labor market. Their policy stance shifts accordingly – they first pause on tightening macro and regulatory policies, and then start to ease.
In the current cycle, with the sharp pick-up in external demand, policy-makers stuck to their playbook and tightened macro policies to slow infrastructure and property spending. But policy tightening was unusually aggressive this time, with debt/GDP reduced by 10 percentage points in 2021. The property sector has seen the most prominent tightening.
This tightening then became pro-cyclical. The Delta wave and China’s continued Covid-zero approach curtailed the recovery in consumption growth, keeping consumption below trend. Policy measures have extended beyond reducing excessive leverage, with regulatory tightening ranging across the internet, education and entertainment sectors, and a step-up in decarbonization efforts.
The rapid succession of regulatory actions has taken markets by surprise, adding uncertainty, and they have lasted longer than expected, keeping market concerns on the boil.
Now, with GDP growth decelerating to just 3.3%Y in 4Q21 (4.9% on a 2-year CAGR basis), policy-makers have hit pause on deleveraging and began to ease both monetary and fiscal policy a few weeks ago. RRR cuts were coupled with window guidance to banks to allocate credit to SMEs, renewables, mortgages and developer loans. Faster local government bond issuance will translate into stronger infrastructure spending, and property purchase restrictions have been lifted in a number of cities.
This past week, top policy-makers convened at the Central Economic Working Conference (CEWC), an annual meeting that sets the agenda for the economy in the year ahead. Their statement acknowledged that “China’s economic development is facing three pressures: demand contraction, supply shock and weakening expectations”, suggesting to us that they will continue to take action to stem the downturn:
Policy-makers are prioritizing infrastructure investment in areas like pollution alleviation, carbon emission reduction, new energy sources, new technologies and new industrial clusters.
Regarding the property sector, the statement mentioned efforts to “support the commodity housing market to better satisfy homebuyers’ reasonable housing demand”. They will “enhance guidance on housing market expectations” and “promote a virtuous cycle” for the first time in the past decade. The January 2022 reset of mortgage loan quotas will help to lift home purchases.
As for decarbonization, a similar reset of the targets in the new year will alleviate near-term headwinds. Policy-makers have now indicated that they will first invest in alternative energy before curtailing fossil fuel-based energy sources.
These easing measures will complement the sustained strength in exports and a pick-up in private capex, driving the recovery.
The character of regulatory tightening is also changing at the margin. Policymakers are taking a more structured and institutionalized approach, and changes from here on will likely be more incremental. More broadly, the CEWC statement also made it clear that while policy-makers want to divide the economic pie more equally, the pie still needs to grow, which in our view will alleviate concerns about further actions that could weigh on private corporate sentiment.
In terms of market implications, our China equity strategy team continues to prefer A-shares rather than offshore markets. Our China property and Asia credit strategy analysts are bullish on the China property sector as well as China HY property.
The key risk to our call in the near term is the Omicron variant. The effectiveness of containment and tracing capabilities has improved over time such that each successive wave of Covid outbreaks has had a smaller impact on mobility and hence growth. However, Omicron’s greater transmissibility suggests to us that it will keep China’s Covid-zero policy in place for longer and could force China to impose more selective, surgical shutdowns than during the Delta wave.
Sun, 12/19/2021 – 20:55