China's Dilemma

The March data coming out of China is ugly. Both the NBS manufacturing and non-manufacturing PMIs moved into contraction territory in March. This was followed by the release of a very weak Caixin Services PMI of 42, down 8 points from February. The data is mostly a result of China’s continued Zero Covid policy, which has locked down major parts of the Chinese economy. But it is also the result of the war in Ukraine: new export orders fell further into contraction during the month. The only bright spot was construction PMI, which was up to an expansionary 58.1. Some notable areas of weakness:

·       Property sales in 30 main cities were -47% yoy in March vs -29% yoy in Jan-Feb.
·       Auto retail sales were -18% yoy in March vs +10% yoy in February.
·       Pressure remained on SMEs, with medium enterprise activity dipping into contraction and small enterprise activity remaining weak.

This data is likely to lead to more downgrades, and consensus GDP growth estimates are already below the government’s growth target of around 5.5%. The poor data should shock policymakers into doing more to support the economy. Most forecasts are already baking in two more 50bps cuts in RRR and a 10bps cut in the policy rate on the monetary side, and targeted fee and tax cuts for SMEs and manufacturers on the fiscal side, as well as a higher allocation to local governments. With the latter and more local government special purpose bond issuance, a lot of the heavy lifting seems to be placed on local governments.

The 20th National Party Congress will be held this autumn, where the seven-member Politburo Standing Committee will be elected, and President Xi hopes to extend his rule. Mr. Xi would not like to go into this event with the economy limping, unemployment rising, Covid still raging, and the equity market being one of the worst performers in the world.