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Why China’s economic measures may not be enough to drive up consumer demand

  • Featuring
  • Analyst Jing Zhang
  • Commodity
  • Metals
  • Topic
  • Coronavirus and Commodities

China's economic activity has started to recover from the late-May COVID-19 resurgence, while the government has also been stepping up fiscal and monetary stimuli to support the recovery. However, recovery this year is likely to face a bumpy ride and remain relatively weak compared to the waves in 2020 and 2021, with the spread of the omicron variant proving more difficult to contain.

The slowdown in property sector will only further compound China's economic challenges. Expectations for any steel demand growth for the remainder of 2022 may need to be tempered.

The omicron resurgence lasts longer

China took less than two months to contain the COVID-19 outbreak in 2020 and the delta variant resurgence in 2021. But due to the highly contagious nature of the omicron variant, it took China nearly three months – from early March to early June – to control the coronavirus outbreak in 2022. And this came with a price.

China employs a dynamic zero-COVID policy toward the pandemic, which means certain social restrictions and lockdowns will be repetitively implemented in the foreseeable future to contain new waves of the virus, keeping the rate of economic and steel demand recovery slow.

To minimize the economic cost in combating the pandemic, several major cities in China such as Beijing, Shanghai and Shenzhen have shifted to normalized nucleic acid testing to avoid a large-scale lockdown.

Smaller cities are unlikely to afford the high cost associated with the regular and large-scale nucleic acid testing. Their social restrictions to prevent the COVID-19 resurgence have to remain in place, and implementation of lockdown may not be avoided when COVID-19 comes back knocking.

Market confidence gets pummeled

The immediate adverse impact on domestic consumption from the omicron outbreak is not as strong as it was in early 2020, but persisting uncertainty in the wake of the pandemic and weak household income has hit China's consumer and manufacturer confidence harder in 2022 than in the past two years.

China retail sales

In April, not only did consumption of expensive non-essential items such as cars and jewelry fall sharply, demand for cheap non-essentials such as cosmetics and communication equipment also dropped faster than in early 2020.

Consumers are buying less, which will slow down the recovery of China's domestic consumption for the remainder of 2022 compared with the recovery seen in 2020 and 2021.

Sluggish domestic consumption as well as the adverse impact of the COVID-19 on manufacturing logistics and operations have also hit the confidence of manufacturers, a key contributing sector to the economy that plays a major role in driving metals demand.

When the COVID-19 first hit China in February 2020, the index of the Chinese manufacturers' expectations of production and business activities fell sharply to 41.8 points, but it rebounded strongly by 12.6 points to 54.4 in the following month, according to China's National Bureau of Statistics data.

In the latest wave of COVID-19, the index improved mildly to only 53.9 points in this May from 53.3 in April, when the number of new infections peaked.

China's manufacturing capacity utilization rate turned downward from Q3 2021 due to sluggish domestic demand. The decline in the utilization rate gained pace in H1 2022, as shrinking overseas demand, deterioration of property sales and the COVID-19 outbreak further dampened demand for Chinese manufactured goods.

China manufacturing capacity

Manufacturing fixed asset investments have been trailing the capacity utilization rate, which indicates the expansion in manufacturing and its incremental steel demand – even after the pandemic is contained – will be limited.

China steps up policy support, but more on prevention than stimulus

Under the pressure of poor consumption, sluggish manufacturing and a debt crunch in the property sector, the central government has recently introduced a series of supportive policies.

These measures, however, appear to be mainly aimed at preventing further downturn in the economy rather than boosting economic growth.

Key measures to revive China's economic growth
2022 2021 2020
Tax rebate Yuan 2.6 trillion Yuan 1.1 trillion Over Yuan 2.5 trillion
From National Financing Guarantee Fund to enterprises Yuan 1 trillion Yuan 754.2 billion Yuan 400 billion
Vehicle subsidies Tax cut to 5% from 10% for passenger cars of 2.0 liters and below, priced under Yuan 300,000/unit, from June 1-Dec. 31 n/a n/a
Issuance of railway construction bond Yuan 300 billlion Yuan 300 billlion Yuan 210 billlion
Issuance of new local government special bonds (for infrastructure projects) Yuan 3.65 trillion Yuan 3.5844 trillion Yuan 3.6019 trillion
Rural highway construction 150,000 km 160,000 km 269,000 km
Airlines Emergency loans of Yuan 150 billion; Issuance of Yuan 200 billion of bonds to support the aviation industry development; gradual increase in domestic and international passenger flights Reduced costs by nearly Yuan 10 billion for the aviation industry Emergency loans of Yuan 110 billion
Source: government announcements

Largely increased tax rebates and financing support will ease financial pressure of China's enterprises and support their business expansion. But manufacturers' willingness to expand has been largely dented by weak consumption and uncertainties of the COVID-19 resurgence.

The reduction of passenger car purchase tax will boost China's car sales and production to some extent in the remainder of 2022, by bringing forward the demand from 2023. But the improvement is unlikely to fully offset the downturn in engineering machinery and home appliances caused by both falling overseas demand and slowing property construction.

The downturn in China's debt-strapped property sector is unlikely to be reversed at least within 2022, and the latest announced fiscal support for the construction of railways, highways and other infrastructure projects seems conservative, indicating the hidden debt of local governments have remained a concern to the central government.

Moreover, most of the fiscal support, especially from the local government special bonds, is expected to be diverted to less steel-intensive projects, such as power generation, water conservation, as well as the so-called "new infrastructure" like big data centers, AI or intelligent logistics.

In H1 2022, China's fixed asset investment in power generation, gas and water supply increased by 15.1% on the year, and water conservation by 12.7%. Steel-intensive sectors received much less support, with investments in highways down by 0.2% on the year, and investments in railways lower by 4.4%.

Of course, both the manufacturing and construction sectors are expected to see their activities increase and steel demand improve from March-May levels, as China gradually steps out of the pandemic situation. Fiscal support to infrastructure will also take effect in H2 2022, partly offseting headwinds to steel demand from the property sector.

However, steel demand rebound may be more like a flash in the pan, while the slowdown in property sector will continue to dent China's economic growth and lead the overall steel demand down a notch in 2022.

Weak consumer confidence, another major factor undermining economic growth and steel demand, requires full opening of the society and a stronger stimulus to recover. While the full opening is unlikely in the foreseeable future, stronger economic stimulus, if any, may have to wait until after the 20th National Congress of the Communist Party in around November.