Global Source Partners
Andrew Collier | Jul 24, 2020
China has clearly been one of the success stories in handling the coronavirus. The flattening of the curve was a reflection of the nature of the tightly controlled political system. The numbers may not be completely trustworthy but even at multiples the caseload is still much lower than in other countries. As a result, the economy has picked up more quickly than elsewhere in the world.
However, the latest data for economic activity in China shows a continued split between sectors relating to heavy industry and infrastructure and the retail portion of the economy. Power generation and steel production are at high levels while passenger traffic remains low, and other indicators of local activity, such as traffic congestion, are weak.
China may be able to carry the economy forward through the industrial sector alone. But there are several red flags:
- Fiscal stimulus aimed at infrastructure is generating less efficient growth.
- Debt levels continue to climb.
- Small business – a driver of growth and employment – continues to struggle for access to capital.
- For the oil market, inadequate storage infrastructure may make further purchases for the strategic reserve difficult.
For these reasons, China may have a sluggish recovery, due as much to structural economic problems as the virus itself. This will be reflected in oil demand.
Global Source Partners
China’s investment strategy – back to the state sector
The key to China’s economic rebound is the nature of the country’s stimulus. After reducing shadow banking, China in the past few years has emphasized private credit through the bond market and private borrowing such as mortgage loans.
This includes corporate bonds, along with bonds issued by the quasi-private/public local government companies (LGFVs). However, most important have been programs such as an increase in local government infrastructure bonds.
The target for these bonds was raised from RMB2.15T in 2019 to RMB4.75T in 2020. In addition, the fiscal deficit is increasing from 4.9% in 2019 to 11.6% in 2020. And that does not include off-balance sheet financing. Local governments are facing an RMB 11T fiscal deficit, partly due to tax cuts to help small businesses. This is another anchor weighing on future growth.
The corporate bond market has been particularly strong.