TS Lombard with the note:
Sub-consensus H1/21 growth has led us to downgrade our full year forecast to 8.8% yoy from9.3% yoy. But don’t be misled: this isn’t the start of a China crash, just a mark-to-market. GDP growth in Q2/21 came in at 7.9% yoy, and showed unexpected improvements in domestic demand as retail sales rose 0.7% MoM. Our proprietary TSL estimate of GDP put growth at11.46% yoy, down from 20.8% yoy in Q1/21. Headline numbers and the sectoral breakdown show a gradual decline in activity and continued supply side-led growth. China will not drive the global economy, but nor is it likely to become a major dragon activity. We maintain our view of neutral monetary policy and targeted fiscal easing only in H2/21, broader easing is not necessary to boost growth. We also keep our forecast for a return to pre-Covid trend growth of 5.5% yoy inQ4/21. For markets, stabilizing data and a neutral, not easy monetary policy suggest the recent bond market rally is overdone.
Consumption surprised to the upside in June. Since February, we have been cautious on household spending.We continue to expect a weak service-sector recovery to weigh on wage growth, consumer confidence and, ultimately, spending. Delta variant outbreaks add to the downside risk to retail sales. China’s vaccine policy favours the working age population over the elderly, which leaves a portion of the country’s spenders on the side-lines.
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The gain in retail sales last month was manufacturing-led. Strong wage growth for migrant workers–up 17.6% yoy (vs 13.8% yoy in Q1/21) amid high demand owing to the export boom–helped rural retail sales grow 21.4% yoy. Elsewhere, urban disposable income growth, the key to a sustained recovery in domestic demand, improved somewhat, as did urban spending. Our proxies for urban households’ propensity to consume–insurance spending and the PBoC savings survey–flat-lined over Q2/21, supporting our forecast for a slow and steady consumption rebound.
Exports and industrial production remain the core economic locomotives. The Delta variant is helping China’s export competitiveness as orders are being rerouted to the PRC amid Covid-19 outbreaks in trade competitors. Exports beat consensus in June, growing 32.2% yoy. PMI data and anecdotal reporting indicate that the spread of the Delta variant in SE Asia will continue to support China export growth in July. However, we still expect a gradual fall in exports over H2/21as DM economies loosen mobility restrictions and consumers switch from goods to service consumption.
External demand is feeding into industry, which registered a record-high capacity utilization rate of 78.4% in the second quarter. Industrial production is running at a two-year growth rate of 6.5%, above pre-Covid levels. Although output is high, downstream producers are facing a margin squeeze, as weak domestic demand inhibits their ability to raise prices in order to offset surging commodity costs. This was a factor behind the PBoC RRR cut announced last week.
On the investment side, real estate FAI continues to defy tighter credit restrictions, increasing at a two-year growth rate of 8.2%. We expect the “three red lines” (hard limits on debt and balance sheet leverage) policy on developer leverage to finally weigh on property investment in H2/21, bringing growth down to a 5% two-year average rate by yearend.
Infrastructure spending has been weak, slowing from 11.8% ytd yoy in May to 7.8% in June, reflecting a relatively tight fiscal policy stance. Local government bond issuance was very slow throughout H1/21: approximately 30% of the annual special purpose bond quota was issued. At the same time, growth of local government revenue has exceeded that of expenditure, and NDRC approvals of infrastructure projects have been limited. Beijing has kept fiscal stimulus in reserve and has plenty of room should domestic or external demand disappoint.
All in all, activity remains supply side-led with domestic demand improving only slowly.We(and officials in Beijing) see downside risks to consumption and external demand but little prospect of growth dropping sharply. Rather, the composition of activity is likely to shift overH2/21 as exports and property investment decelerate and infrastructure FAI and household consumption gradually pick up. China will not drive global growth, but it is unlikely to become a major drag on activity. We maintain our forecast of a return to the pre-Covid trend growth rate of5.5% yoy inQ4/21.
The data released today reinforce our view that the RRR cut is not about boosting headline growth. Rather we think it is focused on relieving margin pressure on SMEs and allowing smaller banks to increase NPL recognition. We maintain our view of neutral monetary policy stance and targeted fiscal easing only in H2/21