On Monday at 10pm EST, China will release its report on Q1 GDP and high-frequency indicators for March. Surprisingly strong industrial production and investment data in January-February suggest that Q1 GDP growth is likely to be at or near the 5% target set for the government for 2024 as a whole. But this is one of those occasions when a “good” print could be negative for investors, by reducing the urgency on the part of China’s leadership to address weak domestic demand.
A key feature of China’s recovery since the pandemic has been the divergence between strong growth on the supply side of the economy – industrial production and fixed asset investment – and anemic growth in domestic demand, particularly consumption of goods. In a special report last week, we looked at the international ramifications: rising trade frictions over China’s ballooning manufacturing trade surplus and charges of excess capacity (link HERE). As we noted, the supply/demand imbalance also has major domestic ramifications for China, including prolonged deflation which in turn has weighed down corporate revenue and earnings growth.
Without urgency to shift course, Beijing will stay high on its own supply
Beijing’s manufacturing-centered economic strategy, and reluctance to directly stimulate household consumption or take comprehensive measures to rescue property developers, is one of the key factors why the supply/demand imbalance has persisted. Heading into the Q1 GDP report, there are few signs that the economic or political dynamics behind the imbalance are shifting. March PMIs suggested another month of robust production (see our write-up HERE), but indicators for the household sector and broader private demand have been less impressive:
- Inflation came in worse than expected, with the CPI slowing to 0.1% y/y (from 0.7% in Jan-Feb) and PPI deflation worsening to -2.8% y/y (from -2.7%)
- In the credit data, new household and corporate loans were both down from March 2023
- Employment data in the PMIs suggest another month of anemic job growth, which has held back the recovery in household income and consumption
- Continued doldrums in property. Per Bloomberg, “weekly new home sales in 50 cities dropped 55% in the four-week period to March 29 from the average in 2019,” weaker than the rate of -39% at the end of 2023
The ideal outcome for the Q1 GDP report would be strong growth that comes with clear signs of a recovery in domestic demand, such as meaningful improvement in March retail sales and quarterly household consumption, and even signs that property activity is starting to bottom out. A demand recovery would make growth less dependent on stimulus and reduce the risk of entrenched deflation.
A less positive outcome for investors – and significant risk for this GDP report – would be strong headline numbers that are powered largely by the production side of the economy, with domestic demand staying subdued. GDP growth that is broadly on track with the leadership’s 5% annual target will make it harder for officials within the system to advocate for a change in stimulus strategy beyond the relatively moderate support outlined at the National People’s Congress (see our summary HERE). Continuation of that status quo amid weak domestic demand would mean:
- The likelihood that the cyclical recovery will run out of momentum by mid-year, after the current round of fiscal stimulus runs its course. Beijing will eventually add further stimulus, but as happened last year investors will be in suspense as to when new support will arrive and whether it will be enough; and
- Continued deflationary pressures and weak nominal growth, which will constrain the recovery in corporate earnings and the outlook for Chinese equities
Two shifts in approach may be necessary in coming months for Beijing to sustainably boost private sector demand:
- More support for household income and consumption, either directly or through stimulus policies that focus squarely on employment and boosting the labor-intensive service sector (as opposed to the current obsession with advanced manufacturing)
- A more comprehensive approach to restructuring the debt of property developers, without which a recovery in housing sales and investment will be particularly difficult.
Adoption of such measures faces political obstacles and policy inertia. It will likely require unambiguous signs that the current manufacturing-first approach is unsustainable before Beijing shifts its strategy.
