China: Restrained stimulus

We are downgrading China GDP forecast to 5% and 4.5% respectively in 2023/24, from 5.5% and 5.0% previously.  Based on subdued high frequency economic data including industrial profits alongside meetings with various industry leaders in Shanghai/Beijing, the slowdown has been intensifying lately. The confluence of short term and long-term factors clouds the outlook in 2H23.  Gradual interest rate cut is difficult to offset negative structural factors.

The outlook of private consumption, which occupies 37.2% of GDP in 2022, is benign. Consumers’ willingness to spend is constrained by three factors. (1) There has been a structural change of consumer behavior due to less purchase desire for goods after experiencing 3-year demises of covid.  This is evidenced by divergence of traffic and retail sales recovery. Domestic tourist traffic during Dragon Boat festival advanced 119% far more than 2019 level, but tourism revenue correspondingly recovered at a slower rate of 95%. The big divergence between catering (+35.1% YoY in May) and consumer goods sales (+10.5%) growth is another piece of evidence. In fact, share of catering and F&B amongst total retail sales accelerated from 20.5% in Jan-May 2019 to 23.2% in 2023, compared with the fall of clothing and cosmetics from 11.5% to 10.5%.

(2) Dwindling consumer confidence about the future is at play. Based on PBOC survey, share of preference for more saving deposits stayed elevated at 58% despite that of high inflation expectation fell to historical low of 23.1%. This is reflected by the rising deposits in the bank.  Long term socioeconomic factors such as falling birth rate/marriage rate and rising youth unemployment also weigh on propensity to consume.  This is reflected by the decline in sales of housing related goods such as home electronic appliances, furniture, and decoration, with its share amongst total retail sales fell from 8.4% in 2019 to 6.2% in 2023.

(3) Positive wealth effect from ever surging property prices nationwide is absent. The 70 cities newly built commercial residential buildings price remains 2.1% below 2021 level in June. Primary market transaction and project launches were also 32.2% and 47.2% below 2021 level. Reflecting the very sluggish outlook, real estate investment and floor space started fell by 7.2% YoY YTD and 22.7% in May. Developers are very cautious on land auction except first tier cities. Only 46.6% of the land in 2nd tier cities were sold at premium. This compares to 71.6% of 1st tier cities.

State driven investment is rising in sectors such as high-tech manufacturing, semiconductor production facilities, environmental science, and data center.  Fixed asset investment advanced 4% in May YTD, which is far below the trend growth in the past 3 years and pre-covid (2015-201) as growth of private sector investment fell 0.1% in YoY YTD led by manufacturing investment.  The market is currently speculating a stimulus fiscal package in summer. The scale however will unlikely be gigantically equivalent to RMB4trn deployed in 2009 due to tight finance of local government contradicting the requirement of expansionary fiscal policy to spur growth. Even if special infrastructure bonds is further increased, the transmission dynamics is likely to be compromised by the precarious financial situation of local governments as some of their outstanding borrowing surpass 120% of income, which already breached the alarming debt risk threshold set by the Ministry of Finance.  Due to tax breaks and falling land sales, the combined income from public and government fund budgets also fell 6.3% y/y to RMB28.2 trillion.

FDI has been falling sharply lately (see chart) probably due to intensifying Sino-US tension.  It declined 3.9% y/y to USD84.35bn in May, the third straight month of decline. At the time of this writing, China just announced to restrict the export of gallium and germanium (two key metals for producing semiconductor; widely used in EV and fiber optic cable) to the US ahead of US Treasury Secretary Janet Yellen’s official visit to Beijing.  Such conflict dynamics efficiently reinforces corporations’ plan to diversify global supply chain to hedge geopolitical risks.  That in turn will weigh on external trade.

Exports year-to-date grew 0.3% while imports contracted 6.7%.  Trade with the US and Europe experienced respective contractions of 12% and 4% YTD, while bilateral trade with ASEAN increased slightly by 2% YTD.  The divergence between export and import growth also partially reflects the impact of China+1 strategy to diversify exports to other countries and the declining share of processing exports (requires the import of raw materials to produce). This peculiar situation in turn expanded the trade surplus tremendously to USD360bn in the first 5 months of this year.  In fact, trade surplus will likely well exceed USD1 trillion in 2023, surpassing USD877 billion (+30% YoY) registered in 2022. 

Growing trade surplus means external trade is bringing foreign reserves into the country. On the monetary policy front, PBOC may further trim the required reserve ratio in 2H as around RMB2.9 trillion worth of medium-term lending facilities mature. Replacing these expiring funds through broad RRR cuts would inject permanent, low-cost liquidity into the banking system. The authority is also expected to deploy structural tools complementing fiscal policy to bolster credit growth, such as re-lending programs for infrastructure financing.

The goal is to enhance total social financing (May: 9.8% y/y), which has been growing at a slower pace than money supply (May: 11.6%) since early-2021. Mounting disinflationary pressure (Jun CPI: 0.0%) also justifies further loosening of monetary policy. However, the effectiveness of monetary policy will unlikely be too strong given business losses are mounting, and companies/individuals are unwilling to take on additional loans. 

Given PBOC’s interest rate cuts have just begun and the Fed is not done hiking rates, further weakening of the RMB and will likely trigger capital outflows exerting downward pressure on the onshore A-share market and Hang Seng Index. Historical facts suggest this will likely be the case. The 5.7% depreciation of the RMB against the USD in 2018 contributed to a 14% drop in HSI on the back of Sino-US tensions.  This round the relationship between US and China is much intense than 2018 on multiple fronts. Industry such as energy, real estate, and airlines, which tend to borrow more in USD, are particularly susceptible to RMB weakness.

Our latest downward revision of GDP growth in 23/24 is largely in line with consensus between 5% to 6%.  Variance stems from the view on the magnitude of fiscal boost and monetary policy loosening ahead and their resultant impact on economic growth.


Hong Kong SAR: External headwinds driven downgrading

The downward revision of HK GDP growth to 4.8% from 6.5% in 2023 is attributed primarily to subdued external trade performance. Slowdown of the global economy is evident in exports data of key trading partners in May: India (-30.7%), Japan (-26.4%), Taiwan (-24.7%), Singapore (-18.9%), Netherlands (-18.5%), the USA (-17.5%), China (-17.5%), South Korea (-15.3%), UAE (-10.5%), and Vietnam (-0.5%). 

Dwindling domestic demand in China weights particularly hard on HK given 60% of exports go to the mainland led by electrical machinery, apparatus, appliances & electrical parts (-19%), office machines & automatic data processing machines (-33.1%), professional, scientific and controlling instruments & apparatus (-27.1%) and photographic apparatus, equipment & supplies (-13.7%).

As the Federal Reserve and ECB are yet to pause hiking rates (See Macro Insights Weekly: Central banks and recession risks), the outlook of the global economy will likely gravitate towards a downturn.  Likewise, China’s second half is at best cautiously optimistic under the assumption of deploying a stimulus package and further rate/reserve requirement ratio cuts.  The situation calls for reassessment of net exports of goods and services contribution to GDP, which is a negative figure of 3.7% points, contributing to downward GDP forecast revision in 23/24.

As far as domestic demand is concerned, rebound of private consumption continued to improve after 1Q23 albeit at a slower pace as evidenced by buoyant retail sales data and a very tight labor market with seasonally adjusted unemployment rate staying at 3.0% for the three-month ending May.  Labour force also recorded YoY rebound of 2 months in a row. Retail sales and restaurant receipts were back to 90% of the pre-covid level. Car and jewelry sales, anchor of longer-term consumer confidence, registered more apparent YoY rebound of over 50%, compares to headline overall retail sales of 18.4%.  The rebound of consumer spending had been behaving in line with improving tourist inflow particularly from China. In 2Q, visitor arrivals were equivalent to around 60% of pre-pandemic level, up from 50% in February-March. 

Going forward, further upside of consumption is limited by a sluggish property/equity market.  The Hang Seng Index was one of the worst performers of global equity market this year. It plunged by 19.1% from its year-high in Jan. Likewise, Centaline Leading Index also retreated by 1.6% from its 2023 peak in Mar. The recent weakness RMB may also weight somewhat on tourist arrivals. The correlation between YoY change of USD/CNY against retail sales and Mainland visitor arrivals was -68.9 and -39.5 during 2011-2019. Private consumption will likely advance at a slower pace in 2H23, partially to be cushioned by consumption vouchers.

The investment component of GDP, Gross Fixed Capital formation, which contracted by 13 quarters of contraction over the past 5 years, has slowly returned to positive growth trajectory.  Due to ongoing rate hikes in the US and a subdued China, the outlook of it is difficult to be too optimistic. Total loans and advances fell 4.3% in May. Amongst the total, loans for use in Hong Kong (including trade finance) decreased by 1.7% in May, which is consistent with subdued money supply growth. Total HKD M2 decreased respectively by 0.7% MoM in May but rose slightly by 1.5% YoY.  Loans used outside Hong Kong also declined 11.0%, which is consistent with 16.7% plunge of foreign currency loans.

The composite CPI registered 2% YoY advancement in May, inched lower from 2.1% from previous month. The drag primarily comes from the housing component (40.3% of CPI) that registered 0.5% increment only given the ongoing downturn of the local property market.  In fact, it is still 0.8% below its peak in mid-2020. Caution that the following items registered apparent increases in prices: alcoholic drinks and tobacco (19.6%), electricity, gas and water (16.6%), clothing and footwear (5.8%), meals out and takeaway food (3.9%).  On the contrary, durable goods such as electrical appliances, video & sound equipment, and computers & telecom equipment within the composite CPI fell 3.7% YoY, which is an indication of either weak consumer confidence ahead or permanent change of consumer behavior after 3 years of COVID, which substantially reduced the consumption desire for goods. 

As such, HK GDP for 2023 is lowered from 6.5% to 4.8%. For 2024, we maintain our forecast at 2.0% against consensus of 3.0%.


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