China Economic Policy Response

As the first country to implement tough measures to tackle the COVID-19 pandemic, China was also the earliest to relax lockdown measures and allow activity to gradually return to normal. In many ways, the focus has shifted from public health to addressing the economic effects of shutting down large parts of the economy earlier in the year and how local businesses can recover while the rest of the world is still tackling the virus.

The policy outlook for the world’s second largest economy was the subject of a webinar that was part of HSBC’s recent China Conference, where two subject experts discussed how the rest of 2020 could pan out from both economic and currency perspectives.

“The pace of the recovery has been slower than most people expected,” said Hongbin Qu, Chief China Economist, Co-Head of Asian Economics Research, HSBC. “The restarting of production has been fast, but the demand side has been slow to catch up.”

Employment in focus

The effect of the virus on China’s labour market has attracted large amounts of attention in recent months, overshadowing the GDP growth rate, which is typically the headline economic metric for China.

COVID-19 delivered a hard hit to workers, with urban unemployment rising sharply in the first few months of the year – up nearly an entire percentage point to 6 per cent in April and 5.9 per cent in May* compared with before COVID-19.

Despite the dramatic change in a metric that is typically stable in China, Mr. Qu says that the main employment metric does not fully reflect the impact that the pandemic has had on the labour market. He cited data that showed the number of migrant workers who had yet to return to their urban homes reached 50 million by the end of March*. These workers are not fully included in urban employment numbers, and if they were fully added he said, unemployment rate could be significantly higher.

Another way of looking how the economic lives of workers have been affected is via their spending, and the evidence points to a situation where real average disposable income per person fell by roughly 4 per cent year-on-year in the first quarter*. “This will have an impact on consumption,” he said. “The supply side has already resumed operations and shopping malls have reopened, but consumer spending is still weak.”

In the second half of the year, Mr. Qu expects that China will continue to face headwinds. In addition to weakness in domestic demand, he said that continued tensions with the US will create additional uncertainty to the economy’s trajectory. He foresees the recovery to be U-shaped, with a gradual improvement over the coming quarters.

The policy response

This backdrop helps outline the options available to policy makers. The traditional emphasis on growth was put on hold, as the Chinese government decided at the annual National People’s Congress to not give a growth target this year. The policy response to the current downturn will be selective and targeted, said Mr. Qu, compared to the more dramatic response that followed the 2008 Global Financial Crisis.

In terms of fiscal stimulus, he expects the government to spend money in a variety of ways. There will be financial relief for SMEs via tax reduction and subsidies. There will also be infrastructure spending – on both traditional projects like railways and subways, as well more high-tech projects, such as the installation of 5G networks. He predicts that there will be double digit infrastructure spending growth in the second half of the year, which is a substantial rise, but much more moderate than what was seen a decade ago.

For monetary policy, there will be an accommodative approach, ensuring that there is enough liquidity in the system. “We expect cuts in the reserve requirement ratio and rate cuts to encourage commercial banks to cut lending rates and extend loans to the real economy,” he said.

RMB – stability in 2020

HSBC’s view at the start of 2020 was that the renminbi would have a relatively stable year, and despite the dramatic events in the first half of the year, this still remains the bank’s baseline scenario, said Paul Mackel, Head of Emerging Markets FX Research, HSBC. This is because many of the cross-border flow metrics remain relatively subdued.

Although there have been some outflow pressures in recent months, excess US dollar demand has been fairly muted, said Mr. Mackel. Currency-related regulations remain strict in China, while exporters have been hording cash for some time, he added.

On a sectoral basis, we can see that the collapse in commodity prices has reduced the demand for US dollar among importers. The cessation in international tourism has also made a meaningful improvement in China’s service sector deficit, which in previous years has created significant demand for foreign currency.

The main thing to look out for, which Mr. Mackel says could affect the renminbi’s exchange rate is continued friction between China and the US over trade. “If the first phase of the trade deal fails and tariffs go back up, the renminbi will probably weaken.”

The base case, he said, is that Phase One deal proceeds. And if this happens, the exchange rate should rest at around Rmb7 per dollar.