This Friday, February 12, marks the start of the Chinese New Year and the Chinese people, like the rest of humanity, will say a hearty good riddance to the last year with hopes for easier times ahead. The Year of the Ox should be better, with vaccines gradually allowing for a return to normal life and China should be able to build on its early economic recovery and resume its very long trend of strong economic growth.
However, the New Year will also bring new challenges. While China succeeded in suppressing the virus through strong public health measures in 2020, its lead in controlling the pandemic could fade in 2021. In addition, China will need to negotiate a strong economic recovery without fueling asset bubbles or higher inflation. And then there is the challenge of China’s relationship with the United States, which will likely be quite different under President Biden compared to President Trump.
For investors, however, it is always important to have a long-term perspective on China. Despite short-term challenges, China appears set to resume a path of strong growth in both its economy and financial markets. This should continue to support Chinese equities and bonds, both of which have some allure for global investors searching for increasingly scarce sources of growth and income. In the noisy world of investing, it is always difficult to focus on only the most important topics. However, it is hard to argue that the outlook for China isn’t near the top of that list.
Getting Past The Pandemic
Despite being the center of the terrible initial outbreak of the pandemic, for much of 2020 China succeeded in suppressing the virus. This allowed its economy to rebound in the second quarter of 2020, even as the rest of the world succumbed to the pandemic. In 2021, however, China’s relative lead in dealing with Covid-19 could fade. The vaccines currently being used in China appear to be slightly less effective than the mRNA vaccines approved in the U.S. In addition, the vaccine rollout appears to be slower in China than in the west and reaching herd immunity for China’s 1.4 billion people was always going to be a more challenging task than achieving the same goal in the United States or the European Union. Ironically, this is particularly the case because China avoided the painful development of natural immunity seen in much of the rest of the world from massive rates of infection. While China may eventually achieve greater levels of vaccination than in many western countries, it may take longer to get there and it is quite possible that the U.S. and Europe could get back to “normal” in the fourth quarter of 2021 before China can quite abandon the need for social distancing and mask-wearing.
A Less Dramatic Policy Push
In a similar way, while 2021 should be a much better year for economic growth around the world, China’s relative lead could fade. In 2020, real GDP in China grew by 2.3%, a dramatically stronger performance than the 3.5% decline in the U.S. and 6.8% fall in the E.U. Part of this outperformance reflected the earlier control of the virus and part reflected strength in trade, with merchandise exports, including medical equipment, rising 3.6% even as imports fell by 1.1%.
However, China also benefited from significant fiscal stimulus, largely in the form of infrastructure spending financed by the issuance of special local government bonds and as well as tax cuts largely aimed at helping companies weather the storm. According to the IMF, the Chinese government deficit (which includes all levels of government), rose from 6.3% of GDP in 2019 to 11.8% in 2020. It should be noted that this 5.5% increase is actually slightly less than the 7.8% of GDP increase in the deficit in the Euro area and the 11.1% of GDP rise in the United States. These large deficits boosted China’s total government debt to roughly 65% of GDP compared to 98% in the Eurozone and 129% in the U.S. However, it should be emphasized that overall levels of indebtedness in China, including corporate and household debt, look more daunting. In addition, 10-year government bond yields in China are running above 3% compared to 1% in the U.S. and close to 0% across the Eurozone, so that debt service is already a more serious issue in China than in Europe or the United States.
Partly in response to this and partly to avoid a further overheating of the housing sector, 2021 should see some fiscal restraint in China, which could translate into some reduction in the growth of government debt and total social financing.
On the monetary side, the PBOC is sending mixed signals. Consumer inflation remains subdued with CPI up just 0.2% year-over-year overall in December and up 0.4% excluding food and energy. However, the construction sector continues to look very frothy with huge building activity, significant levels of vacancies across China and very high home prices and debt relative to income. Concerns about not feeding further property speculation will likely result in a tighter monetary policy than suggested by broader macroeconomic conditions. This could include a willingness to see further currency appreciation even after last year’s 7.1% climb in the Yuan against the U.S. dollar.
These considerations should leave Chinese monetary policy on a relatively even keel this year and, somewhat in contrast to the United States, economic growth won’t be boosted by ultra-easy monetary and fiscal policy.
A New Year In Washington
A new administration in Washington will provide China with both challenges and opportunities. President Biden will likely be just as aggressive as his predecessor in trying to address the trade imbalance between the United States and China.