China’s economic recovery is proving to be slower than initially expected, hit by labour market pressures, weak consumption and a slump in global demand. We now expect GDP to slow to 1.7 per cent this year.

Monetary policy is a key tool in stimulating the economy and at this year’s National People’s Congress, Beijing vowed to remain supportive. Interest rates have already been reduced during the COVID-19 crisis, with additional re-lending and rediscount facilities for agriculture and smaller firms, while lowering banks’ reserve-requirement ratio has also freed up more liquidity into the financial system.

But an expansion of monetary policy usually takes time to filter through into the real economy. Companies increase investment as credit becomes easier and household spending rises but the transmission into industrial production can take around five months and twice as long for credit conditions to be reflected in nominal GDP.

And higher short-term lending alone is not enough to lift manufacturing fixed-asset investment. Profits are also an important source of funding, and COVID-19 knocked manufacturing firms' first-quarter profits down by 39 per cent compared to 2019. We thus expect no significant pick-up in manufacturing investment this year.

Meanwhile China’s high savings rate makes household spending less sensitive to looser monetary conditions. Stable wages and jobs are bigger drivers of domestic consumption.

So, the delay in monetary conditions feeding through into the real economy means China’s domestic growth recovery is likely to remain slow in the near-term. We thus believe Beijing will step up monetary easing, with credit growth accelerating by lowering interest rates and reserve-requirement ratios even more this year.

The boost of faster money supply and aggregate financing may lift real GDP by 0.9 percentage points if growth in both M2 – broad money – and TSF, or total social financing, rise by 2 percentage points.

Within TSF, most of the pick-up is likely to filter through into new infrastructure projects such as 5G infrastructure, electric-vehicle charging stations or traditional schemes including high-speed rail and water conservancy. These infrastructure projects will be boosted by the issuance of 3.75 trillion renminbi (USD525 billion) of special local-government bonds this year. Healthcare spending will be boosted by 1 trillion renminbi of special central-government bonds.

At the NPC, policymakers indicated a goal of lifting lending for manufacturing investment by 5 per cent. Targeted interest-rate cuts should help, but easier credit is not enough for a broad or lasting recovery: profit and business confidence can influence firms’ investment decisions more. Higher domestic consumption or export demand is still necessary to prompt increased investment by manufacturers.

We also think targeted easing for small- and medium-sized enterprises will help businesses to remain operating and retain jobs. The NPC also announced a boost to government guarantees and additional credit support for SMEs, including increasing inclusive lending by 40 per cent this year over last year's level.

SMEs account for the lion’s share of urban employment so these measures can help the economic recovery, especially with the priority focused on protecting employment and supporting people's livelihoods. But a broader-based recovery in domestic demand is needed to shore up growth and bring back jobs.

First published 26 May 2020.

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