COFACE Risk Assessment

Recovery losing momentum

China’s GDP is on track for a rebound in 2021, but the economic recovery is facing pressures into the second half of the year. While the Chinese economy expanded by 12.7% in the first half of the year, the recovery remains uneven and unbalanced, with domestic consumption growth lagging behind the rate of increase in exports and real estate development. Moreover, a sharp rise in prices of bulk commodities, including base metals and fossil fuels, has constrained the profitability of midstream and downstream enterprises. It is expected that there will be more supportive policies from the central authorities, and a greater push to tap into the quota of local government special bonds (mainly to finance infrastructure projects and only about one-third used in H1). Targeted easing of the monetary policy will also be deployed to ensure ample liquidity and improve access to credit, especially for small and medium enterprises.

Exports were resilient in the first half of 2021, driven by a strong demand for technology products, auto parts and metal products. However, there were recent signs of slowing growth in external demand. For instance, the PMI new export orders has declined continuously since March. Although the unemployment rate is back to its pre-pandemic level, at 5% in May 2021, household demand could still be dampened by uncertainty over the trajectory of the pandemic, as well as China’s zero-COVID response to virus flare-ups. The recovery in private investment – which is yet to recover from a 29.5% drop in the first half of 2020 despite a 15.4% year-on-year increase in the first half of 2021 – is expected to continue for the remainder of the year.

The inflation rate is expected to slow, led by falling food prices, particularly pork, which has been declining since October 2020 due to a recovery in local production capacity to pre-ASF (African swine fever) levels. High corporate indebtedness (162% of GDP in 2020) and an ageing population remain concerns to the outlook in the longer-term. Cyclical factors will also continue to weigh on the outlook.

High debt levels exacerbated by the pandemic

The current account surplus is likely to narrow in 2021, in the wake of a reduction in the trade balance surplus. Private consumption, which should gradually recover, is expected to prompt imports to expand at a faster rate than exports. The renminbi has been under upward pressure in 2020, as China recovered quickly after getting the pandemic under control. So far, in 2021, the currency has remained broadly stable, as policymakers loosened currency controls and intervened occasionally on forex markets to stem a steep appreciation. Despite the pandemic-induced shock, China appeared to be spared from capital outflows due to capital controls. China continues to receive a large amount of Foreign Direct Investment (FDI), but an ageing population and a dwindling trade surplus may impair its ability to generate savings that are significant enough to finance adequately the systemic build-up of debt in the long-term.

Debt levels, exacerbated by the pandemic, will remain high (323% of GDP in Q1 2021), with half being owed by non-financial corporations. These corporations, many of which are state-owned (SOE), are struggling with high levels of debt and overcapacity. While SOEs are mostly owned by provinces, defaults on their bonds have been on the rise, as a result of Beijing’s increasing willingness to impose market discipline and to break away from the idea of an implicit state guarantee for SOE debt. While the continued tightening of the shadow banking sector should lead shadow lending to shrink further in 2021 as regulators introduce more restrictions on the sector, these practices make it difficult to assess corporate debt. For instance, China Banking and Insurance Regulatory Commission (CBIRC) announced new rules in June 2021 that restrict banks and wealth managers from using money raised from cash wealth management products (WMP) to invest in financial assets such as bonds and stocks. These products will also be subject to a maximum leverage ratio of 120%. These rules should reduce the incentive for financial institutions to invest cash WMPs in risky assets or extend loans to highly leveraged companies, which, in turn, would help to contain systemic risks.

Domestic demand and innovation

Beijing unveiled the 14th five-year Plan (FYP) and set a GDP growth target of at least 6% for 2021. The new FYP focuses on a “dual circulation” development model that aims to rebalance the economy from a predominantly export-led strategy over the past decades to a domestic-driven economic activity that relies on domestic production, distribution, consumption and innovation. This would help reduce the dependence on foreign markets for economic growth. On the external front, strategic competition and tensions between the U.S. and China is a long-term trend. Biden has taken a tough stance against China, seeking to build a coalition of U.S. allies to confront China, especially regarding human rights violations. Existing tariffs should continue to exert downside pressure on Chinese growth.  While the Phase One trade deal signed in January 2020 had eased tensions, China has been falling short on the import target since then, which could become a threat to the agreement. Through June 2021, China had only imported just under 70% (USD 63.9 billion) of the year-to-date target of USD 99 billion from the U.S.

Source:  COFACE – Last updated: September 2021