Cutting GDP call on delta, inequality blitz

China’s growth path for 2021 is bending lower.

This article was written by Bloomberg's Chief Asia Economist Chang Shu. It first appeared on the Bloomberg Terminal.

A slowdown in the second half was inevitable after the rapid bounce from the COVID slump. Now, it looks set to be more pronounced. That’s due to pressures ranging from a recent delta outbreak and new restrictions on high-polluting industries to a ‘common prosperity’ agenda that’s led to regulatory tightening on the technology, education and property sectors. We are lowering our growth forecast.

Growth was already slowing when COVID-19 flared in Nanjing. The outbreak -- the most widespread in a series since China came out of a national lockdown in March 2020 -- has been mostly brought under control. But the impact on consumption will linger.
Production has run into constraints, from stretched capacity and supply-chain disruptions to flood damage.

Forecast for China GDP and inflation

Source: NBS, Bloomberg Economics

Regulatory tightening presents a more fundamental -- and lasting -- challenge to large swathes of businesses that contribute to growth.
The blitz of new rules is putting sectors from technology to real estate and education under pressure as authorities look to realize goals on social equality, environmental sustainability and risk reduction.

Putting all this together, we have cut our GDP forecasts. We now see growth slowing to 6.5% year on year in the third quarter and 5.5% in 4Q, down from our June projections of 6.8% and 5.6%, respectively. For the full year, we see growth at 8.9%, down from our previous forecast of 9.1%.

Impact on consumption

The scale of the Nanjing outbreak -- the second biggest in terms of confirmed cases and the most widespread since the national lockdown -- shows China has not shaken off risks from COVID-19.

Virus cases in different outbreak episodes

Source: Dingxiang Doctor, Bloomberg

The most pronounced effect of the outbreak was on consumption, with a notable slump in retail sales in July. A drop in consumption is typical during outbreaks but the effects this time around could linger:

A plunge in the services PMI and signals from high-frequency indicators point to a second straight monthly decline in August. That would be worse than during the outbreak in Shijiazhuang and Jilin at the start of the year, which saw a one-month decline.
Consumer caution could continue to damp spending, especially in the event of further, even isolated, outbreaks.

Retail and industrial production in different COVID episodes

Source: NBS, Bloomberg Economics

A ‘zero tolerance’ policy on virus containment is costly in the short term. The stance doesn’t look set to change soon. There have been some discussions about adopting less-stringent strategies to live with the coronavirus, but uncertainty over vaccinations and strained medical resources even at the best of times mean that it will take time for China to shift to an ideal policy framework.

Pressures on production
Developments on the production side are more likely to swing the growth outlook. Downward pressures have started to emerge in recent months after a fairly consistent recovery from the depths of last year’s lockdown-induced nosedive. The slowdown in July was notable.

Temporary factors such as heavy flooding in parts of the country played a role. So too did the new regulatory requirements. Restrictions on steel, coke and cement production since late 1Q, particularly in northern China, damped production.

China high-frequency data dashboard

Source: Bloomberg Economics, Health Commission of China, CPCA, Shanghai Longzhong, CFETS, CUSTEEL

^{Notes: 1. Weekly new Covid-19 confirmed, cases based on data from Bloomberg News and Chinese government. 2.Baidu index, compiled based on users’ search of key word ‘job losses’. 3. Car sales data are from China Passenger Cars Association, but the CPCA week alignments are different from the calendar week we use in the dashboard, so we just refer to the data to show a rough trend. 4. The Car Sales, FX Turnover, Refinery Run Rate, Property Sales and Stock Market are percentage changes from the average of pre-pandemic level (4Q 2019 and the first two weeks in Jan 2020). 5. Steel Rebar Inventory is the % change from its 2019 average level. 6. We removed 10-city metro passenger data from our dashboard, as data have been not available since June 2021. 7. The ratio is calculated as the cumulative number of vaccine does administered, compared with total population.}

Policy outlook

Going forward, production could see some upside -- especially if the global economy holds up -- but regulatory factors on several fronts will be key to the outlook.

With China working toward its carbon-neutrality commitment, production restrictions on emission-intensive sectors are likely to continue.
Policies aimed at reining in a heated housing market have intensified since 2H 2020. Major steps include the “three red lines” policy regulating developers’ funding behavior, capping land sales to three times a year for major cities, and a shift in land sales revenue collection to central tax authorities from local governments.
Tighter measures have also been implemented on education companies and the technology sector.

Against this weaker backdrop, the tempo of support policy is likely to pick up in 2H 2021, following some tightening in 2H 2020 and 1H 2021. But it won’t be aggressive -- the aim is to cushion the slowdown, not jack up growth.

We expect the government to step up fiscal support through increased infrastructure spending. We also think the People’s Bank of China will deliver another 50 basis point cut in the reserve requirement ratio in the next two months. Read more here.

China economics forecast table

Source: NBS, PBOC, Bloomberg Economics

Current inflation risks are cyclical in nature, but the policy approach China is taking points to longer-term perils. The leadership appears to be opting to use non-monetary means to address the problem. Measures to squeeze out speculation in the commodities market are justifiable, but any attempts to directly control prices would distort markets and reduce economic efficiency.