TWS: Aug. 27, 2020

Graph of the Week | Economics

Prepare yourself. Conspiracy theories, bad puns, and graphs galore – this one’s a biggie.

Not all is as it seems

Following its first economic contraction in decades, China’s 3.2% GDP growth in Q2 came as quite a surprise. At first glance, China’s economic indicators paint a rosy picture, but upon closer look, the color may be fading to grey.

Ordinarily, fixed asset investment and household consumption form China’s largest drivers of growth; but of course, these are not normal times. Together, these make up ~80% of China’s GDP in a good year, yet they remained splashed in red at the end of Q2 – begging the question, ‘what’s driving China’s recovery?’

First is the worst, second is the best

Secondary industries like construction, industry, and manufacturing are picking up the slack, driving 60.8% of domestic GDP growth in Q2. Yet, while secondary industry growth typically comes from good ol’ industrial sales, retail sales down 10% in 2020 says otherwise. Somehow, production has continued to climb while consumer spending remains muted – pointing to a lopsided market.

A broad strokes explanation may be that industrial firms are stockpiling goods in preparation for sunnier days…but while this may brighten figures today, darker skies may be on tomorrow’s forecast should consumption continue in its slumber.

If you build it, they will come

While secondary industry firms stockpile goods for sunnier days, Beijing’s economic stimulus has painted gains across construction and industrials as well.

Though total investment in the secondary industry has yet to recover, investment in physical infrastructure like roads and railways has rebounded quickly. July figures raised total growth over 2020 to 2.4% and 5.7%, respectively, while investment across the board in telecom, energy, and transport have increased in step.

Clear eyes, full hearts, empty pockets

The gains should be taken with a heavy dash of salt. Stimulus is limited – and Beijing has deployed more US$500 billion of stimulus in 2020 through loan buybacks and investments while even granting tax exemptions for private firms. But, through its recovery friendly policies, the country’s coffers have been left high and dry after growing its budget deficit by 5% in 2020.

A nippy frost

The Chinese idiom “雪上加霜” refers to a snowfall being followed by a frost, thus freezing the snow. In this case, China’s economic recovery can be seen as the snowfall, and rising interest rates could well be the frost.

China’s growth is lopsided. Despite Beijing’s best efforts, consumption remains weak as households are still feeling the pain over layoffs and pay cuts, while US-China tensions stave off consumer confidence.

On the flip-side, positive indicators like recent trade, manufacturing surveys, and infrastructure investment have painted a rosy yet misguided portrait of China’s quick comeback. As a result, false optimism over the recovery has caused real rates to rise, which has historically led to a chill in lending and spending.

Bottom line: Industrials, manufacturing, and construction have formed an illusion depicting Beijing’s quick recovery. However, not everything is as it seems, as the majority of growth comes from production stockpiling and federal stimulus. With the rise of real interest rates, China’s seemingly sure-footed economy could very well stumble should consumer spending remain frosty.

Economics | Policy

If You Build It, They Will Come Pt. 2

The “road to economic recovery” isn’t just a figure of speech in China, but a call to action. Beijing is using roads and other traditional infrastructure investment to pave its way out of economic trouble. Infrastructure investment for this year is expected to near 10%, up from 3.8% in 2019.

If bells are a’ringing, that’s because Beijing took the same approach to managing the economic crisis back in 2008, when 38% of the entire stimulus package that followed the Great Recession went into public infrastructure development. China’s economy grew by 9.7% in 2008 and increased in the years following, but the gains came at a cost. The country currently shoulders significant debt from that period, which continues to limit the tools in its economic toolbox today.

Bottom line: Beijing knows that infrastructure investment is the quick n’ dirty way to patch together economic recovery, but lingering bad debt still haunts the domestic financial system. Regardless, many stand by infrastructure investment, including the local authorities who are itching to tick off items on their infrastructure wish list. Should recovery hit a bump in the road, Beijing may double down and drive growth the old fashioned way.

Further Reading

Finance | Markets

Over & Back…and Over Again

…and more from the world of Chinese banking, Beijing is once again dancing with the revolving doors of debt. The PBOC will finance CN¥700 billion (US$101 billion) of new stimulus by rolling over two major rounds of loans set to mature at the end of the month.

China was one of the last countries to turn to stimulus, but the first major economy to return to economic growth. Over recent months, Chinese financial regulators have made a sharp U-turn in their recovery strategy – having first tried to attract enough foreign capital into domestic markets through financial reform to rescue its economy from the brink. Despite the PBOC’s best efforts, capital inflows have been slower than hoped, beckoning financial regulators to open the door for monetary policy easing and stimulus.

Bottom line: China’s continued commitment to stimulus despite its strong numbers shows that the country sees rough waters ahead. With the fate of the trade deal shrouded in doubt, flaring geopolitical tensions, sluggish domestic consumption, rising default rates, and a flurry of other structural issues, Beijing sees little choice but to open the financial floodgates for institutions and commercial lenders to keep the hinges on the economy swinging.

Further Reading

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Business | Markets

‘Go Local’ Goes Global

New research points to a widespread movement by companies to move their manufacturing outside of China in a mass migration that could topple US$1 trillion in costs over the next 5 years.

The pandemic that we’ve all come to know and love has caused 80% of global markets to face supply chain disruptions, forcing 75% of companies to re-evaluate their supply chain strategies. Contrary to popular belief, studies are finding that the outbreak has only sped up re-shoring timelines–many companies, particularly from the US and Europe–had already been shifting towards localized production.

The usual suspects are behind the shift: security concerns, climate change implications and disputes over trade. Companies are expecting both lawmakers as well as lower manufacturing costs vis-à-vis newfound progress in automation to help offset the mammoth price tag attached to going local.

Bottom line: Companies are re-evaluating their priorities and placing value on concerns that were previously non-factors. While the pandemic has highlighted the need for globally-diversified supply chains, companies are beginning to attach a higher premium to sovereign risk – or the idea that tensions between countries in disagreement will spill over to companies’ bottom lines. Who’d a thunk it?

Further Reading

Markets | Policy

On Your Marks for High Marks

In the race to clamp down on Chinese companies listed on US exchanges, Washington is giving US colleges a head start. The tip was delivered via letter and warned university endowments to divest their shares in Chinese firms’ stocks by the end of 2021.

In other words, the US government is protecting college funds by giving them the skinny on forthcoming rules that will result in imminent delistings for Chinese companies. According to a 2019 study, American universities, colleges and affiliated foundations invested about 14.5% of their endowments in foreign stocks. Thanks to US-China tensions and various Chinese company scandals, longstanding investor protection concerns have turned into bills, and the government is starting to take preparatory actions before new regulations are rolled out.

Bottom line: First pension funds, now college endowments: the US is clearing the track for the next heat of regulations. On the flipside, Chinese companies can use this news as a heads up to steel themselves against impending co-audits and restating financials, as well as brace for the possibility that Beijing will bar them from sharing sensitive financial information with foreign auditors. Everyone: get ready, set, go!

Further Reading

Economics | Trade

Chinese Demand Taps OBOR to Redraw Global Oil Map

Oil is critical to ensuring China’s growth over the next few decades, and securing it has become a top priority for the nation. By financing multiple OBOR development projects to circumvent key oil supply chains through the Strait of Hormuz and Strait of Malacca shipping lanes, China has chipped away at competing oversight in these regions, allowing it to secure access to resources while strengthening relationships with OBOR partner countries.

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Further Reading

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