Event    

The Chinese economy has strongly recovered from the Covid-19 crisis over the past two quarters (+3.2% and +4.9% y-o-y in the 2nd and 3rd quarter) after a record 6.8% y-o-y dive in the first quarter. GDP growth is expected to fall to about 2% this year, a 40-year record low, and soar to around 8% in 2021 under the assumption that the virus remains under control and the vaccine is widely distributed over the year. The outlook will also depend on new waves of contaminations and uneven vaccination campaigns across the world that might hit global demand for a prolonged period.   

Impact    

After China saw the Covid-19 virus break out in early 2020, its economy has rebounded rapidly since the 2nd quarter. Impressive performances are largely explained by a combination of strict and long containment measures – which have been very successful at stopping the spread of the virus and preventing new contamination waves – and strong government policy support. As a result, the Chinese economy was among the first to reopen this year. In order to overcome a rare deep recession, the government has used various monetary measures such as lower short-term interest rates, accelerated credit expansion, and a battery of fiscal stimuli (amounting to more than 4.5% of GDP). The surge in public investments in infrastructure projects has been decisive in boosting GDP growth. On the other hand, private consumption has been lagging and saw a slow recovery due to weaker confidence, lower incomes and job losses induced by the crisis. However, as observed recently, its recovery is likely to strengthen in the coming months.

The external boost has been another favourable factor. Despite the global demand gloom, exports have shown annual resilience thanks to a large international demand (notably from the US) for medical products and electronics (home office IT equipment) to cope with the Covid-19 pandemic. As a result, the current account surplus is expected to widen this year. It is nevertheless likely to move back in 2021 as supportive factors will wane over the year, and imports will rise on the back of stronger domestic demand. The resilience and rapid recovery of the Chinese economy amid a global gloom have translated into a stronger RMB this year (+6.5% against the USD by 7 December), reaching its highest level since mid-2018. Exchange rate prospects are favourable for the coming months.

The 2021 macroeconomic outlook looks positive. Being the only large economy in the world to post positive growth in 2020, China will be a strong performer next year (real GDP growth forecasted around 8%) after this year’s crisis. It will not only benefit from an improving domestic consumption but also from surging trade and investment flows within the Asian region as the Covid-19 pandemic is better controlled and the recently signed RCEP (Regional Comprehensive Economic Partnership) is expected to further tighten economic links between members. Still, the external environment will remain difficult as Chinese trade will continue to navigate through US trade sanctions and shaken global supply chains. Government priorities are expected to be put on employment (given increased unemployment and inequalities), financial stability and technological self-sufficiency. Although a wide vaccination of the population is expected to occur in the first months of 2021, Covid-19 will remain most dominant risk next year, disrupting domestic activity and international travel.

The domestic debt bubble is another major risk and explains the communist party’s worries and attention. Compared with the huge economic package in the wake of the financial and economic crisis of 2008-2009, Beijing has been far less supportive this time. Its subdued response is explained by the heavy domestic debt burden inherited from that costly credit-driven recovery but also by less fiscal space available. This year’s crisis has indeed further deteriorated the heavy corporate and local government debt. According to the BIS, credit to the private non-financial sector rose from 204.7% (end of 2019) to 221.6% of GDP in the second quarter of 2020. Therefore, to ensure future financial instability, promoting quality lending (including external lending within the Belt and Road Initiative) and cutting the domestic debt burden will be a top government policy in the coming year(s) as the latter reduces the growth potential and threatens financial viability of many companies. This year, a high number of them, notably SOEs, have been defaulting on their debts. A negative trend with rising payment delays and non-payments is likely in 2021 as governments will gradually withdraw support. This being said, even though the State support for SOEs is increasingly less implicit, bailing out systemic companies will still be the rule, at least in crisis times, to avoid social and economic instability. As a result, and taking into account the extended negative Covid-19 impact on public finances and large government spending from local governments, the overall fiscal deficit expected at 11.9% of GDP in 2020 is still forecasted above 10% in 2021. This will maintain the government debt, now above 60% of GDP, on a steady upward trend for the years to come. The third likely government priority, i.e. technological self-reliance, is motivated by the US fight and sanctions against its technological industry that are likely to continue under Biden’s presidency.  

The Covid-19 crisis has barely affected China’s external liquidity position. It remains firmly at adequate levels thanks to stabilised massive foreign exchange reserves which currently cover more than 14 months of imports. This justifies Credendo’s short-term political risk rating outlook remaining unchanged in 1/7. Looking ahead, all of Credendo’s risk ratings are expected to remain unchanged in the short term on the back of political stability and resilient macroeconomic fundamentals.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com