MNI EXCLUSIVE: Unbalanced China Recovery Faces Demand Drag

China's unbalanced economic recovery is facing a drag from sluggish domestic demand even as factory output rebounds, limiting 2020 growth to about 2.5% and raising questions about the sustainability of any new expansionary phase, policy advisors told MNI.

Retail and private investment will not properly recover before the Covid-19 pandemic ends, said Zhu Baoliang, chief economist at China's State Information Center under the National Development and Reform Commission. Gross domestic product could expand by 5% in the third quarter, and by 6% in the fourth, he said.

This would mean that by the end of the year, China would already be expanding near its potential of 6.2%-6.3%, reducing the need for across-the-board reductions in rates or banks' reserve requirement ratios, barring a worsening of the pandemic, Zhu said. Targeted stimulus measures, such as further cuts in reserve requirements for small- and medium-sized banks, may be more effective, but space even for measures such as these may be limited, he said.

While Chinese banks' average reserve requirement ratio is about 9.5%, the RRR for small- and medium-sized lenders has hit a record low of 6%-8.5% after the People's Bank of China cut the metric 10 times since 2018.

CORE INFLATION

Zhu pointed to consecutive falls in the core inflation rate, which excludes volatile food and energy prices, as a sign of the weakness of domestic demand. CIR printed at 0.5% y/y in July, the lowest since 2010, even though headline consumer price inflation rose to 2.7% y/y from 2.5% in June. CIR should continue to fall for the remainder of the year, Zhu predicted.

Soft demand at a time of rapid supply side recovery could store up problems for the future, said Zhao Quanhou, director of the Financial Research Center at the Chinese Academy of Fiscal Sciences (CAFS) under the Ministry of Finance. While GDP will benefit in the short term, inventories could build, hitting production at a later date.

The indicator of finished goods inventory rose to 47.6 in July's official Purchasing Managers' Index, compared with 46.8 in June, according to the National Bureau of Statistics.

Fiscal stimulus, which has concentrated on helping companies resume production, should include increased subsidies for consumption, said Zhao, adding that consumer confidence was constrained by concerns over income growth and Covid-19.

POLICY CHALLENGE

Policy makers will need to react if indicators continue to disappoint investors as in July, he said, noting that the second and third quarters usually make disproportionate contributions to full-year output.

Persistently weak domestic demand will also pose a challenge for the "dual circulation" strategy flagged by the latest Politburo meeting, which calls for boosting domestic demand while attracting foreign investment and stabilising trade.

Jia Kang, former head of the CAFS, said companies should consider selling export-oriented goods at home if foreign buyers flag. Expanding domestic demand is a priority, he noted.

But with domestic markets still suffering from over capacity, diverting production locally may put further strain on growth in manufacturers' profits, Zhao said. Companies relying on oversea orders could also find themselves in trouble as policy turns to emphasising domestic demand, he added, noting that they may lack sales channels and the capacity to innovate for local consumers.