Emerging Markets Debt Daily
China’s Peak Recovery Already Behind UsNatalia Gurushina, Chief Economist, Emerging Markets Fixed Income StrategyJune 01, 2021
China’s recovery is well underway, but it is not yet fully “balanced”. What are the implications?
China’s peak recovery is already behind us, the annual growth rates are about to start normalizing due to the fading base effect (from sky-high 18.3% year-on-year in Q1-2021 to 8% in Q2, 6.2% in Q3, and mere 5% in Q4, according to Bloomberg LP consensus) and policy normalization is already underway. One area that is not yet back to normal is the structure of China’s growth. You often hear that the recovery is “unbalanced”. What does it mean and what are the implications?
The chart below shows the extent of China’s rebalancing predicament. Estimates suggest that during the pandemic, the contribution of services to real GDP growth collapsed to levels last seen in the early 1990s, and it is still well below the pre-COVID averages. As a result, manufacturing has to pick up the slack, which explains a nervous market reaction when the manufacturing Purchasing Managers’ Index (PMI)1surprises to the downside, gets too close to the contraction/expansion border (50.0) or looks okay on the surface (51.0 in May) but has worrying details (May’s drop in new orders and new export orders). Another repercussion is that the services PMI will have to stay well above 50.0—possibly close to May’s 55.2—for an extended period of time to allow the sector fully catch up. This is the reason why we believe the market will remain focused on the weak labor market conditions (the employment PMI remains in contraction zone), partial lockdowns (Guangdong province) and tighter credit availability as potential headwinds (despite rising vaccinations—45.7% of the population).
This is also the reason why “sharp policy turns” are unlikely any time soon, but there will be a lot of policy fine-tuning and on-going targeted support. One area we are watching specifically is government spending. Ministry of Finance’s numbers point to a small fiscal surplus in the first four months of the year. This is fantastic news for government bond holders, but this means more room to extend support for small privately owned enterprises (the small companies PMI was back in contraction zone in May) and potentially public investments if headwinds persist.
Charts at a Glance: China Growth – Services Still Lagging
Source: VanEck Research; Bloomberg LP
PMI – Purchasing Managers’ Index: economic indicators derived from monthly surveys of private sector companies. A reading above 50 indicates expansion, and a reading below 50 indicates contraction; ISM – Institute for Supply Management PMI: ISM releases an index based on more than 400 purchasing and supply managers surveys; both in the manufacturing and non-manufacturing industries; CPI – Consumer Price Index: an index of the variation in prices paid by typical consumers for retail goods and other items; PPI – Producer Price Index: a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time; PCE inflation – Personal Consumption Expenditures Price Index: one measure of U.S. inflation, tracking the change in prices of goods and services purchased by consumers throughout the economy; MSCI – Morgan Stanley Capital International: an American provider of equity, fixed income, hedge fund stock market indexes, and equity portfolio analysis tools; VIX – CBOE Volatility Index: an index created by the Chicago Board Options Exchange (CBOE), which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities on S&P 500 index options.; GBI-EM – JP Morgan’s Government Bond Index – Emerging Markets: comprehensive emerging market debt benchmarks that track local currency bonds issued by Emerging market governments; EMBI – JP Morgan’s Emerging Market Bond Index: JP Morgan's index of dollar-denominated sovereign bonds issued by a selection of emerging market countries; EMBIG - JP Morgan’s Emerging Market Bond Index Global: tracks total returns for traded external debt instruments in emerging markets.
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