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China shows challenges of post-lockdown economic recovery

Being first isn't always best.

As China emerges from lockdown and gets back to work, much of the rest of the world remains in self-imposed hibernation as it tries to manage the spread of the coronavirus pandemic.

With its renowned export machine blunted for now, China will be relying even more on its consumers to drive the recovery after its first quarterly economic contraction on record.

While China's economy is synonymous with exports, private consumption has been the largest component of Chinese GDP growth since 2014. With household spending at 39% of GDP in 2018, compared with nearer 70% for more developed economies such as the U.S. and the U.K., it also has considerable potential for further growth.

"China is exposed to U.S. and EU markets, but to me domestic demand matters a lot more," Andrew Polk, a partner at Beijing consultancy Trivium China, said in an interview. "China is a domestically driven economy."

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Official Chinese statistics show the period of lockdown resulted in the economy shrinking by 6.8% year over year in the first quarter of 2020, the first decline since Beijing began publishing the data in 1992.

Exports have been even harder hit, falling 13.3% year over year in the first quarter. Sales to the U.S. alone were down 20.8% in March and further decline is likely in April as the lockdown ramped up. The U.S. and the eurozone are China's biggest customers, importing $418.58 billion and $299.87 billion worth of goods, respectively, in 2019.

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New orders of manufactured goods — an indicator of export demand — were the weakest component of the Caixin China General Manufacturing Purchasing Managers' Index in March. Having collapsed to a record low 29.0 in February, well short of the 50.0 that marks stability, new orders fell again in March despite the overall manufacturing purchasing managers' index stabilizing at 50.1.

While this may have decimated the Chinese economy in the past, the changing balance of its economy leaves it on a firmer footing. The value of exports has fallen from the equivalent of over 30% of GDP in 2010 to just 17.5% of the Chinese economy in 2019.

"We will continue to see structural improvements in GDP composition, with consumption taking a much bigger part, while trade will be relatively less important," Lynda Zhou, portfolio manager at Fidelity International in Shanghai, said by email.

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That could help the Chinese economy rebound in the second half and avoid a full-year economic contraction in 2020. The International Monetary Fund predicts Chinese growth of 1.2% this year, compared with a 5.9% drop for the U.S. and 7.5% for the eurozone.

Most businesses in China are now open and the country's capacity utilization has returned to 82.8% of the pre-virus level, Trivium data show.

While export data remains key, the outlook for imports is more important as it reflects the strength in local demand, Frederic Neumann, co-head of Asian economics at HSBC Global Research, said in an email.

The headline statistic suggests Chinese demand is relatively strong. Imports declined in March by just 0.9% in dollar terms, meaning a surprisingly low total contraction of 2.9% in the first quarter of 2020. Imports of oil rose 5% in the first quarter with stocks rising much higher than they would normally for this time of year, while purchases of iron ore, coal and natural gas increased by 1.3%, 28.4% and 1.8%, respectively, according to China customs data.

However, all may not be as rosy as the data suggests, according to Mathieu Savary, a strategist at BCA Research.

"China’s imports overstate the current strength of the Chinese economy," he said in an analyst note. "China is taking advantage of low commodity prices to stockpile raw materials, as highlighted by the surge in oil and other natural resource imports."

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Other metrics show the rebound in consumption has been weak so far.

Having contracted by 20.5% in January-February, retail sales were down 15.8% year over year in March. Purchases of clothing fell 34.8% year-on-year in March, while sales of automobiles were down 18.4%.

For Polk, the recovery in car sales will be an important indicator for both the recovery of consumer confidence and industry.

"The supply chain is very complex, you have parts moving around from different parts of China and different parts of Asia. It’s a big-ticket item that is normally pretty commensurate with economic performance," he said.

He agrees with the IMF that China will most likely achieve 1% growth this year, but the situation remains fragile.

"If anything goes wrong at all we're in negative territory, and the next two to two and a half months are critical for determining that path," he said.