Pantheon: Chinese stagflation ends

Pantheon Economics with the note:

Stability and the Easing of Stagflation Risk in China

Chinese growth stabilised in November, as one crisis ended, and the policy response to another gained traction. The official manufacturing PMI rose to 50.1 in November, from 49.2 previously, handily beating consensus expectations, while the nonmanufacturing survey was broadly stable at 52.3, from 52.4 in October. Manufacturing is unsurprisingly faring better with a consistent energy supply, and construction is receiving some support from government infrastructure spending, offsetting the Covid drag on services.

Energy shortages were a major drag for manufacturers in September and October. Their resolution by November saw the output subindex jump to 52.0, from 48.4 in October, underpinning the headline gain. Factories reopening also meant a major bottleneck was removed, or at least widened, reflected in improved delivery times, as shown in our first chart. New orders, including imports, are also on the rise now that factories need parts again, in a good sign for China’s trade partners.

Better still, inflationary pressure is easing. The manufacturing input price index plunged to 52.9 in November, from 72.1, while the producer price subindex dropped to 48.9, from 61.1 in October. In part this reflects the reduction in supply chain congestion, but the major driver is energy prices. October saw a huge one-off increase of 20-50% in electricity costs for Chinese industry, as a consequence of the energy price liberalisation needed to restore supply. Prices remain elevated, but have not seen a similar increase, prompting the improvements in the PMI subindices. PPI inflation this month should stabilise in year-over-year terms as a result.

The combined effect of the output gains and reduction in inflationary pressures is that the stagflationary impulse from China is receding, or even going into reverse. One transitory factor, at least, really is transitory. It won’t fix every problem, but will provide welcome relief at the margin for global policymakers.

Policy support starts to be felt

Chinese policymakers have been active beyond the energy markets. Beijing has urged local governments to get busy in the bond markets too, and to use the funds to support growth through infrastructure projects, as we have previously discussed here. It looks like they are finally obliging. The construction subcomponent of the official non-manufacturing PMI jumped to 59.1 in November, from 56.9, despite ongoing weakness in the property sector. Local governments finally seem to be putting their bond revenues to work.

We do not think stronger construction suggests a real estate rebound, despite recent easing of policy for the sector, a narrative we think has been overplayed.

Bond issuance by developers is increasing, but it is concentrated among SOEs, rather than providing relief to those firms in the headlines. Land sales are still struggling, and property sales are still falling. SOEs will use their new funds to support local governments through future land auctions, and indirectly through taking on the distressed assets of their private sector competitors. A surge in construction would not be a wise move, politically or financially, for SOE developers right now. The proof of the pudding will be this month’s investment data.

Stronger construction activity largely offset a drop in the service sector, to 51.1 in November from 51.6.

We had expected a larger decline, given the breadth of Covid outbreaks across China in November, and a case count that came close to rivalling the disruptive Delta wave back in August. One significant difference is the apparent resilience of business optimism, relative to the Delta wave. The business activities expectation subcomponent fell only slightly, to 58.2 from 58.8, compared to an August drop of 3.3 points. Businesses seem more confident that outbreaks will be quickly contained by policy action. The emergence of the new Omicron variant will put this new faith in
government control to the test, particularly as and when it makes its way onto the mainland, but for now we will have to scale back the expected hit to the service sector from Covid flare-ups.

All in all, the PMIs reinforce our recent call for a stabilisation of momentum in November, rather than an aggressive rebound. They also provide some early holiday cheer, as the stagflationary drag from China is on the wane.

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