The Chinese economic outlook for 2022 has deteriorated as the year has progressed. Since the beginning of 2022, analysts have downgraded forecast GDP growth by around 0.5% and the expectation is now that the economy will expand at a rate nearly 1 percentage point below the government's official target of 5.5%. In addition to the impact of the war in Ukraine and its influence on international trade and commodity prices, weak Chinese growth also reflects local factors.
Since March, the rising number of Covid-19 cases prompted the Chinese government to impose strict lockdowns in many parts of the country, including Shanghai and the capital Beijing. This is despite the fact that the absolute numbers of infected people have remained relatively low. However, a concern for the Chinese authorities has been that vaccination rates are low amongst the elderly, hence the tight restrictions, which are thought to have affected about 400 million Chinese people.
Economic data for April, the first period fully affected by the new anti-Covid measures, were weak. The 20% year-on-year drop in goods purchases was the steepest since early 2020 when the pandemic began. Furthermore, industrial production shrank from a year before. However, recently released PMI data for May showed a marked improvement, especially for the non-manufacturing (services) sector.
In contrast with the US and Europe, Chinese inflation remains well contained at only 2.1% year-on-year in April, below the official target of 3%. This gives the People’s Bank of China (PBoC) and the Chinese government flexibility to provide additional support to the economy. As part of official measures to support the housing sector and the economy more broadly, on 20 May the PBoC reduced the rate on long-term loans by 0.15 per cent to 4.45 per cent immediately benefiting the mortgage market. Expectations are that monetary policy will be loosened further. Additionally, Premier Li Keqiang recently stressed the importance of supporting growth, raising the expectation that more measures will be announced soon.
This is one reason why Chinese equity markets have performed poorly in 2022. Another part of the underperformance of the MSCI China index in US dollars can be attributed currency weakness: the renminbi fell by 4.5% against the US dollar in the year to 2 June. In turn, this is associated with the observation that the yield gap between US and Chinese rates has disappeared since the start of the year. Chinese equities began the year already trading at a valuation discount to the rest of the world. A consequence of ongoing underperformance this year is that the valuation discount has widened. Moreover, with a trailing P/E ratio of around 11 and earnings cyclically depressed, valuations look cheap in absolute terms.
In summary, the Chinese economy has been unequivocally weak this year against a background of ongoing Covid lockdowns and problems in the rest of the world. It is not so surprising that Chinese equity markets have underperformed weak global equity markets in this context but what has been disappointing is that the implemented policy response has been so feeble, in contrast with previous periods of crisis. What is now needed is for the authorities to follow through on their promises of supporting the economy. If that were to happen in a credible and sizeable way, the prospects for Chinese equities would improve quickly and meaningfully.
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