China: Delta worries dim outlook; policy easing warranted
- Recovery under pressure as retail sales, industrial production and FAI growth slowed in July
- A zero-tolerance approach helped to contain the delta variant outbreak
- But quarantine and lockdown will dent consumption and economic growth in 2H
- Extreme weather conditions, shortage of computer chips and electricity hamper production
- Implications for investors: We see scope for another reserve ratio cut in the coming months
July’s data suggested China’s roaring recovery from the pandemic was losing steam. Growth in industrial production fell for a fourth straight month to 6.4% YOY, compared with 8.3% in June. Fixed asset investment increased 10.3% YTD in July vs 12.6% in January-June. Retail sales retreated to 8.5% YOY from 12.1%, confirming our cautious view on the sustainability of the June’s rebound. The surveyed jobless rate edged up 0.1%ppts to 5.1%.
Among others, concerns about the delta variant will weigh on retail spending and economic growth in 2H. The latest wave of cases erupted in Nanjing and spread to more than half of the country’s 31 provinces. Provinces with local communities currently classified as medium- and high-risk account for more than one-third of national GDP. The deteriorating outbreak has triggered tightening of virus controls. Millions are shelving travel plans during the peak summer season. High-frequency indicators of mobility from domestic flights to road congestion already show signs of slowing.
Past outbreaks suggest regions more affected by infections will experience slower recoveries in consumption and household income. We noted aggregate real income per capita growth of 5.4% in 2Q21 (2-year average growth) was still 1.4%ppt off the 1Q19 level. The pinch extended beyond catering and tourism. Some refiners reportedly scaled back operations as the decline in traffic crimped fuel consumption.
New infections have been largely contained in areas with heavy industrial activities so far. Hence, we do not expect the delta variant to interrupt the manufacturing sector severely. But there are risks on the horizon, evidenced by the recent moderation in leading indicators. The decline in July’s PMI, for instance, was concentrated in the polluting industries such as ferrous metals smelting. This, alongside strict limits on coal usage, underscored the effects of China’s de-carbonization drive. Meantime, extreme weather conditions such as high temperatures and flooding in some areas affected production. A shortage of computer chips and electricity will also put a damper on output.
Externally, reopening is propelling recoveries in manufacturing in major trading partners – dampening China’s export share. Already, we reckon the recent fall in shipments was largely driven by the likes of non-pandemic products including household appliances and furniture. By destination, exports to the US weakened a fifth straight month in July. EU-bound trade also retreated sharply.
The closure of the Meidong terminal, which processes 25% of the cargo that passes through Ningbo-Zhoushang port, will aggravate port congestion and delay planned sailing. The slowdown in exports will be more pronounced in the coming months as base effects wear off.
All told, more fiscal and monetary support is warranted to put a floor beneath economic growth. We expect the local administration to quicken bond issuance to fund infrastructure projects. Net local government special bond issuance in 1H only amounted to 28% of the annual quota. On the monetary policy front, we reiterate our view that PBOC may step up liquidity injections amid concerns over the faltering recovery and looming municipal bond supply (see “China: Inflation and monetary policy outlook”, 27 May). Inflation doesn’t seem to be a constraint, with CPI growing a meagre 1% in July.
Echoing our call is the Q2 Monetary Policy Implementation Report released last week. The authority pledged to keep liquidity ample and step up support for small firms and the manufacturing sector. In our view, the likelihood of another RRR cut is increasing, particularly since banks’ excess reserve ratio is now hovering at the lowest level since 1Q18.
To read the full report, click here to Download the PDF.
Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.
The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.
DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-878-9999. Company Registration No. 196800306E.
DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.
The information set out in this website ("Information") is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation. This Information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation. This Information is published for general circulation only and does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person. Visitors accessing this website should always seek advice from an independent financial adviser regarding the suitability of the Information referred to herein (taking into account the specific investment objectives, financial situation and/or particular needs of each person in receipt of the Information) before making any investment and/or any purchase in reliance of the Information. Please refer to the actual research publications for important disclaimers and disclosures, where applicable.