China sets ambitious growth target despite new lockdowns

Putnam Fixed Income team, 04/11/22

China has introduced lockdowns in Shanghai — its largest city and a global financial center — and in other cities and regions amid surging Covid-19 infections. We believe there will be significant economic costs from these disruptions. Against this backdrop, Beijing has been boosting fiscal spending. More than 1 trillion yuan (around $158 billion) in profit transfers from the central bank to the government will be part of the funding.

Winner and losers

China has recently seen its biggest outbreak of infections since the original Wuhan wave in 2020. Major production centers, including tech hub Shenzhen, auto hub Jilin, and Shanghai, have been placed in partial or full lockdowns. The economic cost is likely to be larger than the previous waves and will add pressure to global supply chains. Despite the government's shift toward a "dynamic zero-Covid" policy, we believe these measures will remain.

The Russia-Ukraine War will likely negatively impact global growth. But China will likely emerge as a long-term beneficiary and probably be the least affected by the commodity shock, in our view. China is said to have agricultural product stockpiles. CPI inflation has so far been insulated from the surge in global energy and food prices. The negative impact of the war has so far been on the capital markets. Investors pulled money out of China amid fears of the delisting of American depositary receipts (ADRs) and defaults by real estate firms. These concerns were tempered by assurances from Chinese authorities.

That said, some economic activity, including retail, auto, electronics, and catering sales, surprised on the upside during the first two months of 2022. These improvements do not reflect the recent Omicron outbreak. Property investment rebounded while new home prices continued to decline in February. Investment in infrastructure and manufacturing rose.

China's new home sale prices continue to trend lower

Sources: Bloomberg, National Bureau of Statistics of China, as of February 28, 2022.

In March, however, manufacturing and non-manufacturing activities contracted. The official manufacturing Purchasing Managers' Index (PMI) fell to 49.5 in March 2022 from 50.2 in the prior month. Lockdowns and the war are likely part of the story. Some local companies said that some overseas orders were canceled due to geopolitical risks.

Ambitious growth policies

In early March, China held its annual National People's Congress to set the policy priorities for the year. Premier Li Keqiang proposed an ambitious growth target of 5.5% for 2022. Special bond issuances from local governments and cash surplus from state-owned entities will be the main funding sources.

Li also called for higher credit expansion and lower effective lending rates, pointing to further cuts in the reserve requirement ratio for banks and the policy rate. The measures will be front loaded, Li indicated, and "stand-by policy tools" will be utilized in a timely manner. In our view, the growth target indicates more policy easing in the near term.

But at its mid-March meeting, the People's Bank of China (PBoC) unexpectedly held its key interest rate for one-year policy loans unchanged, despite rising Covid infection rates and higher growth expectations. The central bank probably maintained the rate to support the yuan amid higher capital outflows. Given the government's annual targets, we believe there will be more pressure on financial institutions to reduce their lending standards and rates.

1 trillion yuan boost from central bank

To support its growth target this year, the government said it plans to draw on savings from previous years and transfers from state entities to keep debt under control. The PBoC — which is considered a state entity — said it will transfer more than 1 trillion yuan in profits to the government. The central bank said the funds will come from income accumulated over the past few years on the nation's foreign exchange (FX) reserves.

The PBoC usually, but not regularly, transfers its profits to the government. This year's operation, however, is much larger, and the income is marked under a different fiscal account. China analysts have attributed this to the FX reserve earnings that have not been fully realized. Given the recent freeze on Russia's FX reserves, we suspect this (a reclassification) could be in preparation to change the composition of China's reserves from the dollar and other Western currencies.