The negatives:

a. Slowing trade and manufacturing

After rebounding from the December low, China’s official manufacturing purchasing managers’ index (PMI) has now eased lower over March to May and returned to contractionary territory amid softening external demand.

The export recovery has also faded, while import demand has been weak. In 2023, we expect China’s exports to decline 3.0% year-on-year and imports to only grow 2.0% year-on-year.

b. Record high youth unemployment

While China’s overall jobless rate has edged down to 5.2%, youth unemployment has risen to a record high 20.8%. Fresh graduates not finding jobs is a concern. With an estimated 11.6 million graduates expected to enter the labour market in the coming months, youth unemployment will continue to climb.

There is also a skills mismatch in the short-term that will reduce labour force productivity. Specifically, China’s re-opening is benefitting low-end services companies, with fewer job openings for higher educated graduates.

To combat this, China’s State Council unveiled a plan to boost employment of new graduates by expanding recruitment in state-owned enterprises (SOEs) and providing hiring subsidies to small and medium-sized enterprises (SMEs). Given time, hiring numbers will rise when business sentiment improves, especially if China retains a pro-growth policy stance.

Looking more broadly, if the overall unemployment rate continues to fall and employment indicators within PMI surveys continue to recover, household income should rebound with a slight lag.

c. Geopolitical tensions, COVID infections, and tightening liquidity

US-China tensions have been elevated since the start of 2023, and it is unclear if bilateral relations will improve significantly now that high-level communications have been re-established following US Secretary of State Antony Blinken’s visit to Beijing.

A resurgence of COVID infections may also impact economic growth negatively in the short-term as production activity declines due to increased employee absenteeism. However, this impact should quickly wane when the COVID wave subsides.

Tighter global liquidity could also depress China’s domestic credit growth and put companies and corporate profits under even more pressure.

d. Potential repeat of summer power shortages

A potential drag on economic growth in the early part of 2H 2023 may come from a second straight summer of severe heat, threatening a repeat of last summer’s power shortages. This could trigger power rationing, forcing factories to shutter production and disrupt supply chains.

In 2022, China’s industrial production declined over July and August when power restrictions were imposed on various manufacturing hubs along the Yangtze River. The affected industries produced materials, such as electronic components, chemical products, aluminium, steel, non-ferrous metals, polyester, and textiles.

China’s State Grid Energy Research Institute has already warned that central, eastern, and southwestern provinces in China are likely to experience electricity shortages during a heat wave, and power supply may be tight across the entire country.

The saving grace is that China has prepared by ramping up coal production, reducing the risk of a protracted nationwide power crisis. However, in the long-term, China will need to solve the structural problem of power investments lagging electricity consumption growth.

e. Property sector needs more support for confidence to return

Property sales across China had a strong start to 2023, and home prices rebounded slightly in most cities over the first four months of the year. The recovery, however, has slowed, with existing home prices in 100 Chinese cities falling from May due to concerns about the economic outlook and financing concerns.

Sentiment in the property sector may take longer to fully recover, and more support measures are expected.

Specifically, there is speculation that the Chinese government is considering reducing down-payments in some non-core neighbourhoods of major cities, lowering agent commissions on transactions, and relaxing restrictions for residential purchases.

The positives:

a. Domestic demand will be the shining light

China’s domestic demand has seen a mixed rebound over the first few months of this year.

Consumption recovery was driven primarily by a strong rebound in services spending on tourism, leisure, and restaurants, as the Chinese public cheered post-lockdown freedom by getting outdoors and travelling. The lock-down this time last year in Shanghai and some other cities boosted the year-on-year comparison.

Interestingly, the Dragon Boat Festival holidays in June saw holiday spending come in below pre-pandemic levels even though domestic tourism revenue was strong over the May Day holidays this year. While revenge spending in domestic tourism will decrease slightly over the coming months, it is still expected to remain elevated. Notably, China’s Tourism Academy predicts the number of domestic trips will hit approximately 4.6 billion this year, and domestic tourism revenue will hit around CNY4 trillion, representing a 95% year-on-year jump.

Overseas travel will take slightly longer to fully recover, as this requires more foreign flights to be added and visa application approvals to be ramped up.

On the surface, demand growth for goods appears sluggish as an uncertain economic backdrop deters many Chinese from big-ticket purchases. What needs to be highlighted is that China’s goods retail sales did not decline as much as services spending over 2022, hence the year-on-year growth does not seem as impressive.

We want to highlight one big advantage that China holds, and that is the record high Chinese Yuan deposits. As seen in Figure 9, China’s household savings have surged since the onset of COVID.

Source: JPMorgan Asset Management (30 June 2023).

China’s total Chinese Yuan deposits have hit a record high of nearly CNY275 trillion. To put things into context, this is more than triple the CNY84 trillion market capitalisation of the Chinese stock market. It is also more than double China’s 2022 nominal GDP of CNY121 trillion.

The build-up of Chinese Yuan deposits is positive in the longer run as businesses and households can unleash cash back into the economy via investments and spending. It is inevitable that those Chinese Yuan deposits will be deployed once people feel secure about the economic outlook, leading to a second phase of the domestic demand recovery.

b. China leading the way in green initiatives and renewable energy

Another area often overlooked is China’s active promotion of green initiatives and renewable energy over the past few years. China’s 14th Five-Year Plan has a target of 33% of electricity consumption coming from renewables by 2025, which they are on track to meet. China also aims to phase out internal combustion engine vehicles by 2035 and achieve net zero carbon emissions by 2060.

Notably, China has been leading the push into renewable energy technologies like solar, wind, hydroelectricity, and batteries, with the country leading the world in renewable energy production and renewable investments. Six out of the 10 largest EV battery makers in the world come from China. The market leader, Contemporary Amperex Technology Co. Ltd (CATL), commands a market share of 34% as at 2022, while Chinese battery companies account for 56% of total market share.

This matters as global sustainability is a long-term trend, and being at the forefront of the green movement, China has a big head-start in such technologies and would benefit from exponential surge in demand over the coming decades.

In addition, China has been making large-scale investments in clean-energy transition as it sees immense potential in green energy innovation as the next pillar of economic growth. This is expected to continue and has positive implications for China via jobs creation and exports.

c. Supportive fiscal and monetary policies

China’s political leaders have stuck to a pro-growth policy stance and vowed to keep monetary and fiscal policy supportive to combat economic headwinds.

An important takeaway is that unlike most other countries, China avoided large-scale fiscal or monetary stimulus during the COVID years and has the ability to unleash stimulus if economic recovery stalls.

This is made much easier by benign inflationary pressures. Consumer inflation is at a two-year low and producer prices have been in deflation for nine straight months.

Targeted monetary easing has already started. The first move was when Chinese authorities asked the country’s biggest banks to lower deposit rates. When bank deposit rates become less attractive, capital can be redirected into the stock market.

The People’s Bank of China (PBoC) has also cut its seven-day reverse repurchase rate by 10bps to 1.9%, the first reduction since August 2022. In addition, the PBoC cut its 1-year medium-term lending facility (MLF) rate as well as its 1-year and 5-year loan prime rates (LPR) by 10bps each. This is an acknowledgement by the Chinese authorities that they need to do more to boost the faltering economic recovery.

Looking ahead, we expect the PBoC to reduce its reserve requirement ratio (RRR) to expand the low cost long-term funding source for banks. The PBoC still has the option to guide mortgage rates lower via the 5-year LPR if the recovery in the property market stalls.

In addition, it has been reported that China will announce new support measures to boost domestic demand and the real estate sector.

d. Private sector credit should deliver a positive boost

China’s credit growth started to reaccelerate at the start of this year, with bank loans leading the rebound. While this has turned negative in May, we expect this to be a brief blip. In general, overall credit growth should continue to expand over the coming months as the economy and housing market recovers. Credit growth is expected to peak in 4Q 2023 from low base effects.

Periods of accelerating credit growth have historically coincided with sustained rallies in Chinese stocks.

*The credit impulse index measures the change in new credit/bank lending as a percentage of GDP.
Source: UOB PFS Investment Strategists, Macrobond (30 June 2023).

Despite sluggish recovery, China remains our Top Idea

While China’s economic growth may disappoint in the short-term, we retain a positive outlook for the medium-term. China remains one of our Top Ideas as its economy should continue to outperform that of global peers.

Looking at the IMF’s projections in Figure 11, China will be the top contributor to global growth over the next five years, with its share likely double that of the US. We maintain our China 2023 GDP forecast at 5.6%, above China’s official target of “around 5%”, taking into consideration 1Q 2023 GDP and low base of comparison.

Source: IMF, Bloomberg (30 June 2023).

In summary, more support measures for the property sector is expected, while high household savings mean domestic demand will be the key growth driver to offset external headwinds. A rebound in private sector credit is also expected to continue, and this will be positive for both the economy and Chinese stock markets. Lastly, China’s pro-growth policy stance provides a safety net, and the government can utilise targeted fiscal and monetary stimulus if required.

Chinese stock markets may underperform in the near-term and cause investors to lose faith. However, holding positions with a medium-term timeline can reap rewards given attractive valuations, supportive fiscal and monetary policies, and an eventual upturn in business and consumer sentiment.