China was hit first by the Pandemic, but it also exited first. Its economy is giving some signs of recovery but it is still too early to assess the speed and shape of such recovery. At the same time, the rest of the world has been hit even harder and is barely starting to exit lockdowns that guarded against the pandemic. China’s economy is surely suffering the lack of external demand but there is hope that domestic demand can cushion it. So far, data on domestic consumption and investment do not seem to indicate that this will be the case. In fact, retail sales in April changed -7.5% compared to an average of 8% last year. Fixed asset investment fell -10.3% compared to 5.6% in 2019. Infrastructure investment alone saw a -11.8% negative growth. This is clearly bad news for commodity exporters and, in the case of infrastructure, particularly worrisome for those exporting metals.
Against this backdrop, Chinese leadership met this weekend, for the so-called Two Sessions, in which political leaders offer guidance about the road ahead for the economy. This important gathering was delayed due to the coronavirus pandemic The world´s attention to this meeting that started on Thursday might have never been as high, after witnessing a rather hesitant approach to stimulus since the outbreak hit China in January.
Expectations had been centered on two key issues: the leadership’s announcement (or lack thereof) a GDP growth target for 2020. The growing consensus against such target had, however, a strand of observers calling for a two-year target. The latter could be justified by the very special circumstances related to Covid-19 coupled with the need to guide expectations beyond 2020. The end result has been no target at all. This seems to indicate that flexibility has become more crucial, even more than guiding expectations. Given the importance that the regime gives to stability, not stating this target bears an important message, namely that economic activity this year and probably next year is expected to be poor.
At the same time, and after some hesitation during the last few months, Premier Li Keqiang has finally announced a big stimulus package. On the monetary side, references to lower interest rates and a higher inflation target point to a laxer monetary policy ahead. On the fiscal side, a larger stimulus can be inferred from the announced quota increase for local government bonds from RMB 2.6 trillion last year to RMB 3.75 trillion. As if a nearly 40% increase in financing for local governments were not enough, an additional RMB 1 trillion in Special Treasury Bonds was announced. It should be noted that the last time the Chinese government resorted to these types of off-balance-sheet bonds was in 2007. Finally, the magic of it all is that the target for the fiscal deficit remains low despite the sharp increase in bond issuance, namely, 3.6% of GDP in 2020.
The combination of a large stimulus without a growth target points to the worrisome fact that China’s recovery is far from complete, two months after Covid19 was brought under control. This is especially true on the demand side. External demand remains extremely weak as virtually the whole world was hit by the pandemic but, even worse, also domestic demand is, as the meager retail sales clearly indicate, together with the looming deflationary pressures.
The need for more stimulus is, thus, a no-brainer. Premier Li’s announcement should then be welcomed. The problem, though, is that there no such thing as a free lunch. The mirror image of an additional stimulus is more leverage. The announced fiscal stimulus will raise public debt further unless new fiscal revenue can be found. The latter looks very unlikely unless the leadership decides to divest assets, which is not in the cards. Therefore, all forces point to a higher public debt due to the stimulus announced in the Two Sessions. Our estimate of China’s consolidated fiscal deficit has hovered around 8% during the last few years, which implies public debt has been piling up even before Covid19 hit. While most of the increase is associated with local government financing vehicles, it seems clear that China’s fiscal space is not as large as it used to be. If we also consider the fact that a significant part of China’s corporate debt is in the hands of state-owned companies (about 60% using the universe of listed companies), public debt on a consolidated basis would be higher than that of the US or most European countries. The good news, though, is that China has enough domestic savings to hold this debt domestically. In other words, solutions can be found to reduce the size of the debt once the negative economic consequences of the pandemic are fully under control. In this regard, one should expect financial repression to remain even more pervasive – supported by capital controls- so as to cushion the negative impact of further accumulation of public debt to counter the effects of the pandemic. In addition, China will put more effort to attract capital from the rest of the world to finance its growing debt. This, again, is not positive for Latin America, a region in need of external financing, as China may divert a lot of the inflows into emerging economies in its direction. The good news, from the Latin American perspective, though, is that interest rates in China will be trending downwards making it relatively less attractive. In the same vein, the US increased push for financial decoupling from China may divert funds away from China into Latin America.
All in all, China’s recovery after COVID19 is being painfully slow, especially on the demand side, with obvious negative consequences for commodity exporters and, thus, Latin American economies. The most important political event of the year, which just ended, opens the way for more fiscal and monetary stimulus but, without offering guarantees in terms of a growth outcome, which is a huge deviation from what China’s policymakers have been doing in the past few decades. The trade-off between flexibility and stability seems to be bending towards the former. Secondly, the pile-up of debt which should be expected with the stimulus package can be financed domestically but still China will look for more foreign capital, putting additional pressure on dollar-hungry countries, many of which happen to be In Latin America. Latin America should not be expecting a remake of 2008. In other words, China is not going to come to the rescue this time around.