China’s coronavirus lockdown has caused an unprecedented demand and supply shock. However, consumption has been hit harder than production, causing unsold stocks to build up. Businesses will drawdown existing inventories before they expand or increase their output, thus slowing the post-lockdown recovery.

Industrial production contracted by 8.4 per cent in the first quarter of 2020 compared with last year and commercial services output dropped 11.7 per cent. But on the demand side, fixed-asset investment shrank by 16.1 per cent and retail sales by 19.0 per cent relative to the same quarter of 2019.

As a result, industrial inventories increased sharply between January and March. Stocks of finished goods rose 14.9 per cent compared with 2019. The pace of restocking already exceeds the peak of the last restocking cycle in 2016-18 but it is counter-cyclical, rising when business confidence is at a record low.

The large restocking in the first two months of the year is mainly attributed to the normalisation in production of upstream industries such as metal and chemical production outpacing the recovery in demand of the downstream sectors, including car, computer and consumer electronics manufacture.

Firms destocked during 2019 as US-China trade tensions lengthened: when the ‘Phase One’ trade deal was signed they started to restock. But the continued restocking amid the pandemic was forced on them by an unexpected deep contraction in demand as well as an ongoing slower-than-expected recovery.

The main driver of the future inventory cycle will be businesses’ expectations of demand growth. While many initially thought growth would naturally resume at pre-pandemic rates once containment measures are lifted, the fall in global growth makes this increasingly unlikely. And if businesses now foresee continued weak demand they will scale back output and draw down stock.

There was similar involuntary restocking caused by weak growth during the 2008 global financial crisis with a large inventory drawdown following. That experience shows that rising inventory pressure in a weak demand environment will dampen businesses’ willingness to expand production. This may further delay new investments or lead to lower output, thus reducing the demand for labour.

The Beijing government has made job creation and stability a key policy focus, and more stimulus is needed to lift the broader domestic economy in the wake of a fall in global demand.

To achieve this, more decisive action needs to be taken to support small- and medium-sized enterprises (SMEs) and stimulate domestic demand. We expect to see:

  • Further and extended tax cuts for corporations, especially SMEs, including an extension of the VAT cut by two to three months, plus broad-based cuts to corporate social-security contributions.
  • Easier credit access and lower credit costs for SMEs through expansion of government credit guarantees (financed partly by special central-government bonds), and regulatory ‘carrots and sticks’ for state-owned banks.
  • Increased infrastructure investment through the issuance of RMB3.7 trillion (USD525 billion) of special local-government and RMB2 trillion of special central-government bonds.
  • Further broad-based monetary easing through deposit-rate and lending-rate cuts of 0.3 per cent.

First published 29 April 2020.

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