International | Jun 29 2022
China's GDP growth is forecast to halve in 2022 and the outlook for Australia's resources hangs on the Chinese government's scrambling bid to combat the fall.
-China’s economic growth to halve in 2022
-About-face as slowdown snowballs
-China targeting select industries
-Australia’s exposure
-Broader global economic outlook
By Sarah Mills
China’s economy has been extremely robust, growing at breakneck speed for the past two decades, delivering windfall profits to Australia’s resources investors.
This trend accelerated in 2020 and early 2021, as covid triggered a shift to goods manufacturing and exports away from services in China, and as the country moved to deepen global dependence upon its supply chains.
But as China’s economy matures, covid unwinds and domestic, geopolitical and ESG tensions take their toll, growth in China is expected to decelerate sharply in 2022.
China’s Economic Growth To Halve in 2022
The Organisation for Economic Co-operation and Development (OECD) expects economic growth in China will slide to 4.4% in 2022, a sharp deceleration from the 8.1% GDP and Producer Price Index growth logged in 2021.
S&P Global Ratings in its monthly Asia-Pacific Credit Focus for June expects China’s GDP will grow 4.25%. The agency’s downside scenario is for 3.5% growth, if lockdowns remain protracted.
This compares with the International Monetary Fund’s forecast of 4.4% GDP growth in 2022 and 5.1% growth in 2023.
UBS has cuts its GDP forecasts to 3% from 4.2% and forecasts a shallower rebound in the September quarter. Some analysts are forecasting growth as low as 2%.
The Communist Party’s own forecasts in its Budget and Economic Outlook: 2022 to 2032 published in May is for real GDP growth of 3.1% in 2022 and for growth to meander around these levels for several years.
The Chinese government also predicts a quick return to normal as a fall in energy prices and accommodative monetary policy do their work but, like the West, expects recent low interest rates will not be revisited.
Xi's Prosperity Plan Backfires
The deceleration in GDP reflects directly on President Xi Zinping’s Common Prosperity Plan after the ruling party initiated a crackdown last year on corruption and unproductive investment in the housing infrastructure sector, the internet gig economy, and east-coast power brokers.
Property starts fell -44.2% year on year to April after falling -22.2% in March. Excavator sales fell -61% in April and auto sales fell -48%.
In response, Chinese households are saving; businesses have left the country, and expats and bankers are fleeing to Singapore, Dubai and other parts of the world.
Observers believe China is experiencing a massive brain drain and that it will take at least two years to restore business confidence and for the tanker economy to return to its former growth.
S&P has downgraded much of the country’s financial sector to Stable from Positive.
China also faces elevated inflation, the country recording its highest pace of inflation in four decades; inflation is forecast to hit 4% in 2022. This is mild in comparison to the inflation rates confronting the West.
Still, China is forecast to outperform emerging market countries on a global trend basis and emerging markets generally are forecast to outperform the West.
About Face As Slowdown Snowballs
S&P Global says the government is now moving to fire growth post lockdowns given the pace of the deceleration surprised.
President Xi’s most recent rhetoric has shifted from “prosperity” to “stability” and the government is reinvesting in infrastructure after the pandemic.
S&P Global says China’s policy response is now aiming to return to 5.5% GDP growth in 2023. Some are forecasting as high as 7.5%.
Policymakers are suggesting they are aiming for a “shotgun impact”, built on faster than average forecast growth within EMEA economies.
S&P global expects an up-kick in infrastructure investment that may allow the government to meet its revised 2022 target. This does not necessarily change the Chinese government's long-term predictions.
Nor does S&P expect the shift to stability will change China’s broader narrative on common prosperity, anticipating the government’s focus will be on infrastructure outside of construction.
Meanwhile, the 20th National congress of the Chinese Communist Party is expected to be held in the 4th quarter of 2022 on a date not yet set.
S&P expects the meeting will signal the end of all covid restrictions and the official redirection of funds into new areas of infrastructure investment.
Government Targets Select Industries
S&P says the government is encouraging credit into select industries and into micro and small enterprises (MSE) and that RMB1.1trn in loans will be extended to MSEs; 1.6% of total banking sector loans.
Which industries is the question.
“China’s regulators have encouraged a tightening of credit but (have) encouraged banks to enhance support to “real” economies over corruption-inflated or gig economies, and is pushing lending to the MSE segments,” says S&P. Another RMB1.1trn is likely to be extended in loan relief to the sector.
The agency expects lending to MSEs should increase investment spending in the December quarter, helping China hit short-term and long-term targets at once.
S&P says four major areas will affect private-sector investment:
-the reform of monopolies, particularly in the internet space
-expansion of the middle class with online tutoring at affordable prices (this is also aimed at moving the economy up the value chain into higher tech industries, particularly through vocational training)
-equalising basic public services such as education, healthcare and affordable housing
-greater oversight of high-income earners which is likely to include adjustments to tax systems that strengthen public welfare
How this “prosperity” investment manifests in the broader economy is yet to be seen.
UBS expects politburo support for property, tax rebates, faster bond issuance, and easier LGFV (long-term government financing vehicle) lending to support infrastructure.
The government also plans on boosting rural infrastructure, and connectivity to impoverished western areas.
This aligns with its plan to redirect resources from the wealthy east coast to the impoverished west. In doing so, the government also hits both long-term and short-term ESG targets, says S&P.
A mix of auto and high-tech investment are targeted for the nation’s top cities.
China is particularly focused on electric vehicles, and investment in solar installation and renewables is expected to continue apace. While construction spending has been curbed after last year's crackdown on corrupt housing development, investment in the sector is forecast to continue, but in a more targeted fashion.
Affordable housing is critical to the economy and S&P Global says the government is walking a razor’s edge, as it can’t cut prices too far but needs to encourage growth. A switch from housing development to facilities for the elderly, social housing for the nation's top cities is mooted as a solution.
Social housing is expected to account for more than 10% of new residential housing and plays to the ESG prosperity theme. The majority of this investment is expected to be directed to the top 20 cities and will account for 20% to 40% of housing in tier-one residential cities, says S&P.
Meanwhile, the agency notes that pressure will be on to ensure local property developments are completed (40% of property developers were in trouble by the end of 2021).
The government has also flagged spending programs that benefit the elderly but outside of social housing or possibly nursing homes, the investment in this area is unclear. Investment in rural infrastructure, particularly connectivity, is also forecast.
The government is also examining other methods of economic support that do not rely on consumer spending, in order to keep a lid on inflation.
Demand for agricultural infrastructure should be interesting following the country's worst rains in 60 years; and will depend on many factors from geopolitics to the weather.
One thing for certain is that China is a net importer of food and plans to increase its self-reliance in this area, which could increase demand for agricultural infrastructure over the longer term.
And then there will be the losers.
Better labour protection raises costs, which should hit low-margin industries and improve worker safety, as was demonstrated with China’s national sword policy.
The focus on supply chains and manufacture is also likely to hit dining and entertainment, logistics, hotels, tourism and to some extent transportation, suggests S&P.
In Shanghai those sectors account for 15% of total loan balances, highlighting growing angst between Shanghai and Beijing.
Australia’s exposure
The good news for Australia is that it is not particularly exposed to the losing sectors. The bad news is that the halcyon growth of 2020 and 2021 spurred by Chinese demand is set to moderate.
Australia’s resource and energy exports are forecast to hit an all-time high of $425bn in 2022 according to the Federal Government – a massive 50% above forecasts.
The Department of Industry Science, Energy and Resources March 2022 Resources and Energy Quarterly predicts earnings will return to pre-pandemic levels in FY23.
China accounts for about 40% of Australia’s resource exports and Australia’s trade-to-GDP ratio in 2020 was 43.98%, reports Macrotrends. This has proved a saving grace for the country in a period where the services sectors, which account for 62.7% of Australian GDP, took a hiding.
These figures demonstrate that Australia’s two-tier or dual economy is highly exposed to demand from China.
While emerging markets demand is forecast to grow, China’s growth is forecast to continue to be the strongest of all, suggesting there are unlikely to be any knights in shining armour in a globally slowing economy.
On the upside, China’s stranglehold on rare earths and other critical materials for decarbonisation, combined with geopolitical concerns, is expected to fire up investment in Australian mines as Western countries scurry to diversify their supply chains.
China’s global electric-vehicle ambitions in particular are a positive for the Australian market, but much will depend on domestic adoption and the nation’s success in this market.
S&P has also forecast continued growth in China’s steel, coal, gas and oil demand throughout 2022 and 2023. However, Bejing is planning to invest in its own coal infrastructure, an inauspicious sign for Australia. In contrast, demand for gas remains positive globally.
Rising global inflation and interest rates are expected to subdue commodity prices.
The Reserve Bank of Australia also notes that one of the biggest factors affecting global commodities is population growth and that the process of industrialisation and urbanisation equally increases demand.
These themes are likely to remain part of the Chinese landscape for sometime, particularly as the prosperity theme develops, although the government is working hard at transitioning to arc-furnace steel production, which should act as a counterbalance for steel demand.
On the downside, the Reserve Bank notes China’s population is forecast to fall in coming decades, but for now the nation’s prosperity and ESG themes appear likely to dominate this decade. The country has a long road to haul before lifting the country’s social scores.
When it comes to population growth, India will definitely have a role to play on the global stage.
How these themes play out later in the decades remain to be seen (we examine China and the commodities question in a separate article), but for now the resources sector should continue to garner support, albeit somewhat muted.
Meanwhile, serious investment in domestic recycling infrastructure in Australia should set in at some stage after China introduced its National Sword policy, but it’s like watching a kettle boil.
Broader Global Outlook
A protracted conflict in the Ukraine heightens the risks of a global slowdown as rising global inflation and interest rates take their toll.
Simon Hunt Strategic Services (SHSS) says China is preparing for a global crash in asset values sometime in the mid 2020s, after which the economy will need to reflate and says the government recognises the need to keep its gunpowder dry.
This may explain the Chinese government’s relatively low GDP forecasts.
SHSS predicts a global asset crash is likely over the next two to three years, after which China will be able to embark on its real strategies. While this signals short-term pain for Australia, assuming that assumption proves correct, this should bode well for the second half of the decade.
SHSS notes China has the resources to recover, boasting high savings, a large, cheap labour pool and a supply chain infrastructure second to none. Analysts at Federated Hermes are keeping their eyes peeled to the Ukraine.
“Unless resolved, the ongoing Russia/Ukraine conflict will complicate the global food security situation. Combined with the rising cost of energy and higher borrowing costs, the situation is becoming increasingly worrisome,” says FH.
Federated Hermes notes that BRICS economies are relatively well positioned and that global megatrends will continue to offer buying opportunities and spur investment in emerging markets.
“Within emerging markets, major economies such as China and India did not spend significantly during covid, rather pursuing targeted support measures,” says Federated Hermes.
According to the latter, Brazil is ahead of the curve in tightening monetary policy, while South Africa and Indonesia are benefiting from positive terms of trade due to commodity shortages.
This suggests the BRICS may emerge from covid in a stronger position post the Ukraine War and covid, enhancing the bloc’s bid for an alternative global fiat currency to the US.
The entire Asia region is expected to deliver 44% of global GDP by 2026.
Should Australia’s trade with China suffer as the nation favours BRICS, trade with western countries should strengthen, and Federated Hermes believes Europe is the place to be.
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