China’s uneven recovery continues
China’s Q2 GDP figures as well as some major activity data for June released last week continue to paint a macro picture of strong external demand paired with slower recovery in the domestic economy.
Chinese economy expanded by 7.9% y-o-y in Q2 after surging by 18.3% in Q1. On a two-year average basis, growth picked up in Q2 to 5.5% from 5.0% in Q1. Putting the first two quarters together, the Chinese economy expanded by 12.6% in H1 compared to the same period last year.
In June, Chinese exports grew by 32.2% y-o-y, up from 27.8% in May. In line with the strong export performance, Chinese industrial activity has remained buoyant in recent months. In comparison, the recovery in China’s domestic demand remains slower, with growth generally below pre-covid levels. For example, retail sales expanded by 12.1% y-o-y in June, or 5.3% on a two-year average basis, compared to the prevailing growth rate of about 8% before the covid crisis hit.
While the recovery of domestic demand in China lags the rebound in exports, there are some encouraging improvements on the household consumption and fixed-asset investment fronts. In addition, the rapid spread of the Delta variant of the coronavirus globally, particularly in Southeast Asia, could delay the recovery of production capacity outside of China. This means the strengths in Chinese exports could extend well into the second half of 2021.
We expect a more supportive policy environment in the second half of 2021. The PBoC recently cut banks’ required-reserve ratios (RRR) by 50bps, releasing roughly Rmb1 trn of liquidity into the financial system. This move came as a surprise to the market and may indicate policy makers’ desire to mitigate the impact of the sharp tightening of financial conditions on the domestic economy since early this year. While we do not interpret this move as the start of a new easing cycle, it probably does indicate that policy ‘normalisation’ (i.e. tightening) by the PBoC is over and that its monetary policy stance is now back to neutral.
Fiscal stimulus in China has been noticeable by its absence. For example, the pace of local-government bond issuance so far this year is well behind the levels of 2019 and 2020 and so is fiscal spending. We could therefore see an acceleration in the deployment of fiscal resources in the rest of this year. Combined with a less stringent monetary environment, this may boost domestic demand in the quarters to come.
Overall, the latest set of data releases indicates that China’s economic recovery is still well on track. While domestic demand still lags, we have seen some improvement in consumption and fixed investment in certain sectors. Macro policies may turn more supportive in H2, further helping the recovery. In light of the most recent data, we have decided to adjust our full-year Chinese GDP forecast for 2021 slightly downward to 9.0% from 9.2%— but it still remains above the consensus.