China outlook 2021: Starting off the year on the right foot

China outlook 2021: Starting off the year on the right foot

27-01-2021 | Insight
Despite the havoc caused by Covid-19, China started off 2021 on a much stronger footing than 2020. As the economic recovery gathers momentum and political tensions with the US ease a little, we remain constructive for the months to come.
  • Jie Lu
    Head of Investments China

Speed read

  • Economic growth expected to continue at solid pace in 2021
  • Robust domestic demand and industrial recovery set to drive growth
  • Long-term growth prospects remain intact, quality growth should prevail

After a roller-coaster but still positive year in 2020, the Chinese economy is expected to continue to grow at a solid pace in 2021, on the back of the ongoing domestic recovery and an upcoming global rebound after the Covid-19 shock of March and April 2020. After being the first country to be hit by the Covid-19 pandemic, China managed to bring the contagion under control relatively rapidly and has been leading the recovery pack since the beginning of the second quarter of 2020.

In 2021, Chinese growth will be supported by a favorable mix of consumption and industrial recovery

In 2021, Chinese growth will be supported by a favorable mix of consumption and industrial recovery. Business confidence indicators for the manufacturing sectors have rebounded sharply from the lows seen early in 2020. Moreover, production prices have also been showing signs of stabilization, after months of downward pressure, driving industrial corporate profits back into growth territory.

Meanwhile, the household savings rate for the first nine months of 2020 stood at a record high level of 37% (versus 32% for the same period of 2019 and 2018) — the normalization of the savings rate after the pandemic bodes well for domestic demand. The rise of ecommerce and a consumption reshoring phenomenon, corresponding to a gradual reduction of Chinese overseas spending in items such as travel, studies, or luxury goods, to the advantage of the domestic market, should further boost the consumption recovery.

Figure 1: Gradual return to normal activity

Source: Morgan Stanley Research, December 2020.

After an initial slowdown during the stricter lockdown period of early 2020, online retail sales growth accelerated rapidly and is now back to normal levels seen before the pandemic, around 15%. Moreover, many indicators, such as the box office sales and hotel room occupancy rates, suggest activities are almost back at their pre-crisis levels, after the dramatic collapse seen in February 2020 and subsequently very strong rebound in the second and third quarters.

Exports are also likely to be a tailwind next year, as other countries that have been hit harder by the pandemic in 2020 will continue to recover. Helped by the country’s prompt turnaround, China’s exports have been gaining market share in 2020, despite the renminbi’s strength. As Covid-19 vaccines become available throughout 2021 and developed economies continue grow, total demand for Chinese exports should remain strong, although China may lose some shares gained in 2020.

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Figure 2: Chinese exports boosted by Covid-19

Source: Morgan Stanley research

As the economic situation continues to improve, Chinese authorities should be able to wind down exceptional stimulus measures taken in 2020 to fight the crisis triggered by the pandemic. The fiscal deficit is expected to shrink from an estimated 15.4% in 2020 to 12% in 2021. Meanwhile, credit growth is expected to slow down as the economic recovery continues to mature and monetary policy becomes less supportive. Some marginal tightening could also be on the cards.

Long-lasting tensions with the US

Although Joe Biden’s election as US president may mean some relief for China-US relations, this outcome is unlikely to soothe the long-term rivalry between both countries. A Biden presidency would likely mean a lower risk of trade war escalation, as Biden will likely shift to a more comprehensive, predictable and consistent approach. Yet, competition will remain intense and Biden may be able to federate traditional western allies in his bid to contain China.

A Biden presidency would likely mean a lower risk of trade war escalation. Yet, competition will remain intense

China and the US will need to revisit the trade deal, but we don’t expect that any time soon. For one, targets agreed in the phase 1 deal remain elusive, partly due to the Covid-19 crisis. Since the second quarter of 2020, China has accelerated purchases of manufactured and agricultural goods, as well as energy, from the US. Yet these amounted to only 40% of the 2020 target for the January-September period. This may not lead to a tariff rollback, but it could delay talks of future deals.

From a longer-term perspective, Biden’s pledges in terms of sustainability may resonate better with Chinese policymakers, although his ambitions may ultimately be curtailed by budget constraints. On the other hand, however, the technology rivalry should remain. Even though a Biden administration may prove more lenient regarding technology restrictions to non-critical segments, restrictions will be maintained, underscoring China’s need to become more self-reliant going forward.

In a push to reduce its dependency on the US regarding trade and technology, China recently joined the Regional Comprehensive Economic Partnership (RCEP), the world’s largest free trade bloc. This should help China strengthen its position in Asia. The RCEP gathers over a dozen countries from North and Southeast Asia, as well Australia and New Zealand. The bloc represents roughly 30% of the global population, 30% of global GDP and 28% of global trade.

The aim for China is to get some relief from escalating tensions with the US, by seeking other partners, such as Japan and South Korea. This is especially important for the highly critical components, in particular for the semiconductor industry, that China will need to source abroad if it wants to achieve technological independence. By entering the RCEP, China is sending a strong signal. This is actually the first time Japan, South Korea and China have acceded to the same trade agreement.

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