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As the world continues to grapple with the impact of the Covid-19 pandemic, China's V-shaped recovery is well underway, but cautious consumers weigh on the recovery.
While the rest of the world continues to reel from the far-reaching effects of the Covid-19 pandemic, China is back on its feet and moving toward an enviable rebound in 2021. In spite of a strong recovery in exports and investment in infrastructure, though, domestic consumption has been far slower to rebound. Reviving consumer demand will be critical to achieving policymakers' "dual circulation" economic strategy.
The coronavirus thwarted growth in the world's second-largest economy at the start of 2020.
As the rest of the world came to terms with what the outbreak meant for them and their economies, China, impacted first, also acted first. Travel restrictions were imposed, schools and workplaces closed, factories shut, retail outlets and restaurants deserted as a 1.4 billion-strong population worked toward containing the spread of Covid-19.
China's pioneering use of lockdowns paid off. The economy has been recovering since March, helped by the government's actions to curb the virus as well as by fiscal and monetary support.
The economy expanded by 3.2 percent between April and June after a first quarter contraction, and BNP Paribas expects full-year growth of 2.5 percent. Growth should rebound even more strongly in 2021, but economists at BNP Paribas have just cut their forecast for next year's growth from 8.1 percent to 7.5 percent. Why?
There are three factors behind the changed forecast, says Xingdong Chen, Chief China Economist at BNP Paribas. "The lingering impact of Covid-19, less aggressive fiscal and monetary policy next year and short-term loss in growth potential."
Manufacturing and exports return to strength"The supply-side recovery was definitely much stronger than demand," Mr Chen says, referring to a still-slow uptick in domestic demand even as lockdown measures have been lifted. "Consumption has remained underwater."
Manufacturing activity has improved in recent months as factories reopened and government stimulus boosted infrastructure spending. The official Purchasing Manager's Index for August came in at 51, remaining above the 50-point mark that signifies expansion.
China's exports are also rebounding strongly. The latest data show a 9.5% year-on-year jump in August, the third consecutive monthly increase.
"We expect the current growth momentum of exports to continue to remain through the end of the year or even early next year as we enter Christmas and New Year season.""The strong growth suggests China's export resilience," says Mr. Chen of BNP Paribas. Besides underscoring China's dominant role in global trade, he adds, it is a strong signal that external demand has ticked up as economies across the world gradually re-open. "We expect the current growth momentum of exports to continue to remain through the end of the year or even early next year as we enter Christmas and New Year season," he adds.
Domestic demand lags behindDomestic demand has been slower to recover, though, as Chinese consumers remain cautious.
Retail sales in China still fell for a seventh consecutive month, down 1.1 percent y/y in July and -9.9 percent y/y over the first 7 months on average, as households that are grappling with job losses and uncertainty from the coronavirus outbreak remain reluctant to spend on non-essentials. Imports into China fell 2.1 percent in August, another indication that demand at home is still on the back foot, though partly attributing to the decrease in commodity prices.
Under Chinese President Xi Jinping's "dual circulation" strategy, China will aim to rely on "internal circulation" – or the domestic cycle of production, distribution and consumption – supported by "external circulation." The strategy is seen as a key measure in reducing China's reliance on overseas exports and technology imports at a time of rising tensions with the U.S.
"Consumption is somewhat lagging," says Professor Yiping Huang, Deputy Dean of National School of Development, Peking University. "While the government's fiscal policy focused on infrastructure, tax exemptions and public health spending when the pandemic was hitting the economy, we didn't really have a lot of channels supporting households."
"But overall my expectation is growth recovery will continue," he adds.
From monetary to fiscal stimulusSince February, the People's Bank of China has delivered large amount of liquidity supply, multiple cuts to key lending rates and banks' reserve ratio requirements. It has also given targeted lending support to firms impacted by the virus.
Still, the PBOC has steered clear of large-scale stimulus measures like those adopted by its western counterparts. And as China's economic recovery takes hold, expectations of further monetary policy support are dwindling. "Chinese policymakers are generally satisfied with recovery growth performance so far," says Mr. Chen.
BNP Paribas does not expect further rate cuts, but believes that the government will instead intensify its implementation of fiscal policy. Spending rose by 2.2 percent between January and July versus a 12.4 percent target for the whole year, leaving plenty of room for it to be ramped up if suitable investment projects or fiscal programmes can be found. If not, a substantial amount of spending may be delayed until next year, adds Mr. Chen. That means additional stimulus might not be required.
U.S.-China tensionsTensions between the U.S. and China have clouded the outlook for Asia's largest economy for more than two years and there is no sign of these tensions easing. U.S. President Donald Trump's tough line on China continues in spite of the Phase One trade agreement in February.
Still, BNP Paribas sees potential for the outcome of the U.S. Presidential elections in November to improve the situation. If Joe Biden, who leads the opinion polls, claims the White House, his approach to trade negotiations with China and the rest of the world "may be more institutional and more predictable," says Mr. Chen.
In the face of these external uncertainties, though, "China is determined to shift its growth assault to focusing on domestic demand for 2021. This is the so-called dual circulation, while making internal circulation a priority," he adds.