The National Congress is a bust for China bulls. TD Securities has the wrap.
In a combative 2 hour opening address at China’s 5-yearly Party Congress, which will end on October 22, China’s President Xi talked about an “all-out people’s war” on Covid-19 and the unification of China and Taiwan, including not renouncing the use of force. That Xi is highly likely to be appointed for a third 5-year term as party leader and head of the military is in little doubt. However, of particular interest will be the compositions of the 200-member Central Committee, 25-member Politburo (chief political decision-making body) and in particular the 7-member Politburo Standing Committee which comprise the highest ranking officials in the Party. Whether those seen as close to Xi such as the party chiefs of Beijing, Chongqing and Shanghai, or others such as Premier Li, will be appointed, will be in focus.
As we expected, those that were anticipating an easing of “Zero-covid” were left disappointed. Xi continued to tout the virtues of current policy and if anything, Chinese media have intensified calls to maintain the current stance on Covid. In our view more limited vaccination of the elderly population (especially boosters) and relatively low efficacy of China’s vaccines which are based on inactivated-virus compared to mRNA vaccines, against new variants, means that Covid policy will only be eased gradually in the months ahead. A faster loosening would likely result in a large increase in Covid cases, straining the healthcare system. At most, we may see some tweaks to the current “dynamic clearing” approach to policy but no significant easing for months to come.
As such, the economy will continue to be constrained by Covid restrictions and we maintain our forecast for 2.9% GDP growth this year and limited recovery next year. However, such restrictions are not as severe as they were in March and April, when mass lockdowns were in place. More targeted lockdowns and mass testing will likely continue to be the way forward. For example, the strict lockdowns in Xinjiang and Inner Mongolia recently have not been echoed across the rest of China despite an increase in high risk areas. Nonetheless, new restrictions on travel highlight the difficulties for domestic travel and tourism while continued consumer caution will likely dampen activity in overall service sector industries. One area we will be focusing on is the opening up of China’s borders to travel where we expect a further, albeit gradual easing in restrictions.
As the Congress gets underway, it is no coincidence that today’s CNY fixing was the strongest vs. market expectations on record (close to 9 standard deviations from the average) at 882 pips stronger than the consensus. Over past weeks, the PBoC has stepped up its defence of the Chinese yuan through various measures. We wrote in August that we expected USDCNY to break 7.00 over the coming weeks. Following this break in mid-September, USDCNY has settled around 7.20. Earlier in September, the PBoC cut its foreign currency reserve requirement by 2% to 6%, the first such cut since April followed by the reimposition of a 20% risk reserve ratio on FX forwards. However, these alongside much stronger CNY fixings, have had a short-lived impact on the CNY.
We don’t think China’s authorities are attempting to turn the currency around however, given that much of the weakness in CNY is largely due to USD strength (we note the trade weighted CNY has been largely stable). China’s weaker basic balance position (sum of current account, portfolio flows and direct investment will likely result in further pressure on CNY on the months ahead and we continue to expect a gradual weakening of the CNY CFETS trade weighted index, which would suggest relative CNY underperformance vs. its peers. In the near-term, a break of USDCNY 7.20 is likely imminent and we maintain our forecast for a move to 7.30 by yearend.
