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Wealth Insights Podcast 4

April 2021

Will China's phenomenal growth continue in 2021?

Tommy Xie,
Head, Greater China Research,
OCBC Bank

The Chinese economy was the only major economy to deliver economic growth in 2020.

The stronger than expected 2.3% growth in 2020 was attributed to four factors, mainly China’s effective virus containment measures, supportive fiscal and monetary policies, strong external demand as a result of the global lockdown and a resilient industry-led recovery due to China’s advantageous position in the global supply chain.

Industry production for January and February grew an average 8.1% year on year over the past two years, after adjusting for base effect. This was the strongest growth since China clocked in an annual 8.3% growth for industry production in 2014.

Moving into 2021, most of the factors supporting growth remain intact, except for government support.

The Chinese economy has continued to benefit from a relatively low virus infection rate, and strong external demand as economies re-open. The latest data show momentum in industry sectors remain strong, which in turn will continue to support China’s growth in 2021.

In addition, the low base effect will also underpin China’s growth in absolute terms. As such, we expect China’s economy to grow at a remarkable 20% pace in the first quarter of 2021, and moderate to 9.2% for the rest of the year.

Despite upbeat growth prospects, volatility in China’s financial market has risen significantly since the Chinese New Year, as investors look beyond economic fundamentals.

China’s benchmark index – the CSI300 – has corrected by more than 17% from its peak in the first quarter of this year. The correction in China’s own Nifty Fifty – consisting of high growth companies with strong pricing power favoured by both day traders and mutual funds – was even deeper. For example, the stock price of Kweichow Moutai, mainland China’s largest public listed company by market capitalisation, corrected by more than 27% at one stage.

The recent rise in volatility has been driven by fears about the removal of easing policies, and heightened regulatory risks in red-hot industries such as internet, education and property. Although China has reiterated that there will not be any U-turn in macro policies, the tone from the government does suggest that China is departing from crisis era stimulus.

On monetary policy, the People's Bank of China (PBoC) removed the phrase “maintain continuity, stability and sustainability for monetary policy” from its first quarter monetary policy committee meeting statement. Instead, it states a focus on flexibility and targeted measures. On fiscal policy, China’s State Council also announced in March that China plans to lower the government leverage ratio this year.

Therefore, we expect China’s stock market to consolidate in the near term as investors digest the implications of a gradual shift in China’s policy direction.

Nevertheless, we think the worst may be behind us as China is exiting its easing policy in a calibrated way. The recent regulatory tightening in its internet and education sectors is a preemptive way to deflate bubbles. This is good for a more sustainable development in China’s financial market over the longer run.

Any short-term volatility does not change our positive macro outlook on China in the medium term for three reasons:

First, in its first quarterly monetary policy meeting of this year, China’s central bank highlighted that it will work hard to ensure the economy operates within a reasonable range to celebrate the centennial of the Communist Party of China, which will occur this year. This is likely to cap any volatility in the market.

Second, some investors have tried to draw comparisons between the rally in China’s Nifty Fifty and the early 1970s era of the Nifty Fifty in the US, where American high fliers crashed in the bear market as a result of soaring inflation and rising bond yields. Despite concerns about rising inflationary expectation globally, we think inflation is unlikely to be a problem in China this year, as cooling food prices are likely to keep CPI in check. We expect China’s CPI to be around 2% in 2021, well below government’s target of 3%.

Third, the gradual exit of easing monetary policy does not mean a U-turn in macro policies. China is unlikely to follow the footsteps of other emerging market central banks and hike interest rates this year. The room for China’s bond yields to surge further is also limited.

China’s government bond market has outperformed its advanced markets peers by a big margin year to date. In the first quarter of 2021, China’s 10Y Treasury yield only went up by 5 basis points (bps), as compared to 60-90 bps rise across the UK, US and Australia markets.

We expect volatility in China’s bond market to be low, due to China’s prudent monetary policy and ongoing capital inflows from foreign investors. As such, the risk of disorderly surge in bond yields is low, and this removes a key potential risk to China’s equity market.

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