China’s National People Congress kicks off on Sunday, when retiring premier Li Keqiang delivers the government work report that outlines key economic targets and policies for the year. We published a comprehensive NPC preview report on Wednesday (please see link HERE). In this note I offer a few final thoughts on the main areas in suspense for markets.
Growth and stimulus in play
The aspect of the NPC most directly relevant to markets is what the meeting signals about how aggressively Beijing will pursue growth this year and what stimulus policies it will employ to deliver to get there. The work report on Sunday will lay this out in the form of quantitative targets (GDP growth, fiscal deficit, etc.) and language on policies such as property sector support.
The outlook for these policy settings is unusually uncertain, because so much is in flux:
- How strong and sustainable is the reopening rebound? Recent data, including February PMI readings released earlier this week, point to a strong start but it is still very early days.
- How confident is Beijing in the outlook? China’s leadership made a big mistake at last year’s NPC, setting the growth target at “around 5.5%” even when it was clear that the zero-Covid policy was on a collision course with the Omicron strain. Zero-Covid is now over but there are still risks to the outlook this year, including slowing exports, local government debt risks, weak confidence, and the ongoing shakeout in the property sector. Is Beijing willing to aim high again, potentially locking itself into either aggressive stimulus or another miss of its target and loss of credibility?
- How are Xi and his new leadership team balancing the growth imperative against concern over longer-term financial risks? Since 2017 Xi has generally deemphasized pursuit of high growth in favor of quality growth, including discipline on financial risks. All the same, he is clearly more focused on regaining growth and confidence than he has been in years past. He is also bringing in a new economic leadership team that may be inclined to get off to a strong start as it begins its five-year term.
These dynamics are playing into last-minute speculation about where Beijing will set the growth target and corresponding stimulus policies. There are two contrasting takes:
- “Positive data means a higher growth target.” Reuters has a report out today (link HERE) suggesting that China’s leadership, cheered by recent growth momentum, is now aiming for a growth target as high as 6% for 2023. Market implication if true: a higher growth target would virtually lock in a strong rebound this year – short of a tail risk such as a geopolitical shock – as Beijing would devote stimulus to meet that target. It is also bullish for hard commodities, as Beijing would likely lean on infrastructure and other investment spending to help secure that growth.
- “Positive data means restrained stimulus.” An alternative take, discussed in a Bloomberg News this week (link HERE), is that Beijing has been pleasantly surprised by the strength of the rebound but will cite it as a reason to avoid aggressive stimulus. This interpretation would, on balance, imply that the GDP growth target would stay fairly conservative, such as the target of “above 5%” that has been 22V’s expectation. Market implication if true: A conservative growth target and restrained stimulus does not guarantee soft growth this year but puts the impetus on a rebound in private sector activity and confidence to do the work. This would lean towards our basecase outlook, in which growth is driven mostly by services and consumption, with fairly limited spillovers to global growth compared to a cycle driven by investment and heavy industry. It also sets up the potential for overall growth to disappoint in H2, given that expectations around Chinese households’ willingness and ability to engage in major “revenge spending” over the course of the year may be too high (please see: Avoid excess optimism about “excess saving”, 19 January 2023).
Which take is more likely? One can find support for either take from recent policy signals. Comments from several ministers and policy advisors have implied urgency behind strong pro-growth policies. On the other hand, PBOC’s messaging in recent days has tilted towards take #2, expressing early confidence in the rebound and a focus on normalizing monetary/credit policy and making sure it is sustainable. These aren’t mutually exclusive: monetary policy could gradually move towards normalization while fiscal policy stays loose.
Overall, I have been more inclined towards #2 – disciplined stimulus and a conservative growth target – reasoning that China’s leadership will accept “good enough” growth and not want to commit to overly loose policies given uncertainties around the domestic and global outlook and concerns about rising financial risks.
That more conservative take remains my basecase but there is significant possibility of an upside surprise, such as a growth target of “around 5.5”. However, I am skeptical that Beijing will be so bold as to guarantee growth as high as 6% and the commitments for stimulus that come with it.
Politics: Will Xi’s governance changes spook investors?
Another area of suspense and debate this week has been what to make of Xi’s likely changes both to key personnel and to China’s regulatory apparatus. We already know that the economic team will experience a generational change as a cadre of reform-minded technocrats retires. There are also strong signs that Xi will overhaul some government functions, including putting financial regulatory under a new centralized structure. (Again, please see the preview note for a more detailed discussion)
Do these changes, or other items related to Xi’s reform and regulatory agenda, have the potential to generate a negative market reaction at the NPC?
It will of course depend on the details, which will dribble out. Beijing hasn’t yet announced the closing date of the NPC. The regulatory restructuring will probably be announced in the middle of the meeting (perhaps around March 13), while the financial team will be announced on the second-to-last day of the NPC (anywhere from March 14-19).
My guess – and it is only that – is that if the growth/stimulus signals are positive, investors will largely shake-off news around the regulatory overhaul and the new team. If the news on the stimulus and growth front is disappointing, however, investors may seize on governance changes as an additional reason to be skeptical about China’s outlook and policy orientation.
The reality is likely to be more nuanced. As discussed in the preview note, a new financial regulatory structure and a team of economic officials close to Xi have the potential for financial policy to be better coordinated internally and more effective in pushing through politically difficult reforms, such as those involving local government debt risks. But this new lineup is less experienced and likely less market-oriented than the outgoing team. There is a danger of Xi’s political objectives crowding out efforts to deepen financial sector reforms, and of poor communication to markets that amplifies shocks from China to the rest of the world during periods of stress and uncertainty. We’ll have more to say on these trade-offs once the details are out.
US-China tech competition: the vicious cycle will get worse
On Thursday afternoon, the US Commerce Department slapped 28 Chinese entities on the export control list as part of a broader package. The most notable targets are Inspur, China’s leading server company, Loongson, a leading CPU maker, and BGI Research, the leading Chinese genomics company. Inspur and Loongson will also be subject to the “foreign direct product rule,” placing them off-limits to exports even from third countries that use US technology.
The actions don’t come completely out of the blue, as all three companies had been on other US government watchlists for their connection to China’s military modernization and (in the case of BGI) surveillance programs. Still, there are a few takeaways for investors:
- President Biden may wish to maintain “guard rails” with Beijing that avoid an acute crisis, but this effort – and the desire to see Beijing refrain from providing lethal support to Russia’s invasion of Ukraine – are not stopping very aggressive tech containment measures. The US is not using any carrots to persuade China on the Russia/Ukraine issue, only sticks.
- The inclusion of BGI is a reminder that biotech is now a sector in the middle of tech competition and national security concerns.
- China is unlikely to aggressively retaliate against the latest US controls, focusing instead on building greater resilience against them. In the context of the NPC, these moves will only validate Xi’s belief that China must further scale up innovation and industrial policies to reduce the vulnerability to the US technology controls. The NPC will likely see significant changes to how China coordinates these policies, potentially to include a new structure for advancing the domestic semiconductor industry.
- Those efforts will in turn add to US anxiety about China’s state-backed innovation push, and fuel further claims that even Chinese private sector actors are a tool of Beijing’s geopolitical goals and military modernization (often accurate but also frequently overstated or missing nuance). These concerns will only lead to further restrictions on Chinese companies, extending and likely intensifying the vicious cycle.
A report out this week by the Australian Strategic Policy Institute (ASPI) illustrates why Beijing – for all its deep concern over its vulnerability to the US in areas like semiconductors and financial sanctions – might also feel confident that its best weapon is to advance its leadership in other critical sectors, and why that makes Washington so nervous. The ASPI report concludes that China leads R&D and innovation in 37 out of 44 critical technologies, including key quantum technologies and green energy supply chains. ASPI, which has a hawkish bent, warns that the US and its allies must step up efforts to avoid being vulnerable to a Chinese monopoly or near-monopoly in strategically important areas. I’m not equipped to evaluate ASPI’s assessment, but it helps explain the respective strategies of both Washington and Beijing.
For more on the bilateral relationship and related geopolitical risks, please see 22V’s most recent US-China note: Beijing and Washington’s Relationship Evolved Over the Weekend, It Didn’t Materially Change, 22 February 2023.
