- China's economy is healing but private sector confidence remains fragile. Households are worried about future income prospects and are holding back spending.
- The new COVID-19 cluster at Beijing's Xinfadi market reminds us that the battle is not over and is likely to keep households cautious for a while longer.
- We expect a recovery later this year and into 2021 but if confidence remains weak, policymakers may have to choose either lower growth or more stimulus.
China's economic data for May were a disappointment. S&P Global Ratings thinks the economy is healing and most indicators are moving in the right direction. What struck us, though, were signs that private sector confidence remains exceptionally fragile, at best. This is crucial for the recovery because stimulus-related demand driven by local governments must hand over to the private sector if the recovery is to pick up steam and sustain through 2021. This is what we assume in our current growth forecast of 1.2% for 2020 and and 7.4% for 2021.
Consider manufacturing where private firms account for over 80% of both employment and investment. We estimate that manufacturing firms' spending growth on fixed assets was barely positive in May following steep declines earlier this year. Projects shelved during the COVID-19 shutdown are not coming back quickly. We should not read too much into these data. It might be that firms have enough on their hands getting production lines up and running again. It also suggests that firms may be taking a "wait and see" approach on demand before committing new funds to big ticket capital projects.
More troubling are retail sales which in May were still lower by about 3% than the same month a year ago. Sales are recovering from the collapse in February, which we estimate to be around -30% compared with the same month in 2019. However, until we get back above the 8% trend growth in retail sales, it is hard to conclude that we are seeing the effects of pent-up demand which has been one of the hopes for recovery. This may yet come but it may take longer than first thought.
Soft data also point to nervous consumers. A disclaimer here is that these data only cover the first quarter so it should be no surprise at the height of a pandemic that confidence was shaken. The official consumer confidence survey is volatile but it suffered a sharp decline since peaking in late 2019. More ominously, the People's Bank of China survey of urban depositors found confidence in future income prospects at its lowest level since the survey began almost two decades ago.
An Income Shock And Higher Saving
In concrete terms, persistent caution may lead to higher saving, less spending, and a more drawn-out recovery. China's consumers, for example, may fret more about the level and volatility of their future income given the experience of COVID-19. They could also become more risk-averse, especially if they worry about falling through holes in social safety nets which in China remain precariously large more than two decades after state-owned enterprise reform cracked the "iron rice bowl" of social protections.
Household survey data from the first quarter of 2020 suggest why consumers may be worried. Urban disposable incomes rose by just 0.5% compared with the same period the year before. This is down from the near 8% growth seen in the preceding quarters. Both wage and business incomes, which typically contribute about 6 percentage points to income growth, fell substantially. This decline was not offset by transfers which contributed just 1 percentage point to income growth, just slightly higher than the average growth for 2019. A similar story played out for rural households even though transfers contribute more to income growth for these families.
China's new unemployment rate edged down to 5.9% in May from 6.0% and is close to the official target for 2020, but this is not providing a full picture of the jobs market. This survey-based measure is a big improvement on the old one, which was based on claims for unemployment benefits; however, it still misses migrant workers that lose their jobs and travel back home. Guesses of how many migrants workers are now out of a job are just that--guesses. However, there is circumstantial evidence we can gather to help assess labor market conditions. The urban labor demand-supply ratio is now at an all-time high, but this is because supply has collapsed as migrants have returned home. The employment component of the official Purchasing Managers' Index (PMI) for the service sector, the engine of job creation, cratered in February and has remained below 50 (i.e., contracting) through May. This means that the majority of survey respondents have continued to cut positions three months after lockdowns ended.
Jobs and income security are the top priorities for policymakers this year. Much of this effort will be carried out by local governments and this is one reason for the rise in transfers of at least 2% of GDP from the central government to the provinces, municipalities, and counties this year. This may not be enough to bolster confidence which may explain why Premier Li suggested the "stall economy" could make a comeback in 2020. During last month's government meetings, the Premier noted that the city of Chengdu had generated 100,000 jobs almost overnight by setting up 36,000 street stalls. Street vendors have fallen out of favor in many large cities as local governments attempt to modernize commerce. However, for migrant workers out of a job and consumers looking for bargains, this may be part of the solution for China's near-term confidence problem.
COVID-19 Keeps Everyone Cautious
Caution is also the watchword for China's policymakers with regards to COVID-19. An objective assessment of where China stands relative to other countries with its mitigation efforts is provided by Oxford University's Stringency Index. This index, which ranges from zero (business as usual) to 100 (very tight) is based a range of indicators including school and workplace closures. China is currently over 75 compared to other early exiters, including Australia, Japan and Korea which are all falling towards or below 50. China appears to have retained tighter restrictions on public gatherings, public transport, and targeted stay-at-home requirements.
A cautious mood may be prolonged by recent news of a new COVID-19 cluster found at Beijing's Xinfadi wholesale food market. The number of new infections, so far, is not especially high but its rapid geographical spread--with linked cases reported across the city and even in Sichuan province 2,000 kilometers away--is a reminder that initial success in containment does not guarantee the virus will disappear, especially in a country the size of China. The Beijing authorities will now stress-test their contact-tracing system and even if the cluster can be isolated quickly, the parallels with how the Wuhan outbreak also started in a fresh market may influence behavior for some time.
This Is Why Stimulus Is Being Dialed Up
China's government is not dialing up stimulus to meet a growth target but to boost employment and support household income. Premier Li has set out eight specific economic targets for 2020 and putting aside the unemployment rate (for reasons we noted earlier), one key target is to ensure "growth in personal income that is basically in step with economic growth." The central government is stepping up efforts to get help where it is most needed. The additional Chinese renminbi 2 trillion (US$282 billion, or 2% of GDP) resulting from a wider central government deficit and issuance of COVID-19 bonds will be transferred in full to local governments. While they will have some discretion in how to spend the transfers, the Premier made clear that they should be used to "ensure employment, meet basic living needs, and protect market entities."
This will help but China still falls short of a system where automatic stabilizers--that is, income support to households that is delivered without discretionary decisions by officials--provide a large and timely cushion in bad patches. This may improve but not in time for this economic cycle. Instead, the government is falling back on infrastructure investment as a way to support jobs and income growth, with the added potential benefit of creating longer term jobs as smaller cities benefit from improved transport and communication networks. This can work but it may be less effective than getting support directly to households.
Confidence And A U- Or W-Shaped Recovery
Both the pandemic and private sector confidence will determine the shape of China's recovery. We still think a relatively steep-sided U is most likely as stimulus fires up activity this year before handing over to a more confident private sector in 2021. We assume that prospects for a vaccine build and this convinces households and firms to save less and step up spending. Jobs follow and we enter into a virtuous circle. This means growth of about 5.5% in the second half of 2020 and 7.4% for 2021 as a whole.
The most plausible downside scenario is a W-shaped recovery that plays out over years rather than months. If confidence does not improve, perhaps as a result of intermittent COVID-19 outbreaks, then private sector saving may remain high. Policymakers are left with a choice. First and most likely, apply more stimulus over a longer period that at some point has to be withdrawn. This gets us to the next down stroke in the W as the government shifts its focus back to financial stability over growth. We already assume some of this in our forecasts with a slowdown to just below 5% in 2022 but this would be much more pronounced in this scenario.
The least plausible scenario is an L-shaped recovery. This would mean confidence fails to return and policymakers let growth land where it may. Both outcomes are unlikely based on an assumption that the pandemic will fade over time and policymakers' track record of coming to the economy's rescue, in the short term, when needed.
- China Debt After COVID-19: Flattening The Other Curve, June 4, 2020
- China's New Stop-Go Cycle, May 25, 2020
- U.S. And China Kick Trade Deal Can Down The Road, May 12
- Jobs And The Climb Back From COVID-19, April 19, 2020
- Up Next: The Complicated Transition From COVID-19 Lockdown, April 16
This report does not constitute a rating action.
|Asia-Pacific Chief Economist:||Shaun Roache, Singapore (65) 6597-6137;|
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