A better-than-expected GDP number in Q1 obscures some important short-term headwinds.

Dong Chen & Ling Chen, Pictet Wealth Management.

Chinese Q1 2022 GDP growth came in higher than expected at 4.8% y-o-y, mainly driven by strong business activity data for the first two months of the year. However, growth momentum decelerated sharply in March. This is largely because of the deteriorating covid situation and the Chinese government’s zero-covid strategy, which are weighing heavily on economic activity, especially household consumption. There has been little improvement in the property sector either.

The government and the People’s Bank of China (PBoC) have increased policy support. However, policy easing so far seems insufficient to offset the strong growth headwinds. The PBoC recently announced a reduction in the reserve requirement ratio (RRR) for all commercial banks by 25 bps (and an additional 25bps cut for small banks). But it kept the medium-term lending facility (MLF) policy rate unchanged at 2.85%, signalling reluctance to resort to large-scale stimulus, especially against the backdrop of monetary tightening by other major central banks.

Nevertheless, we still expect further supportive macro policies in the near term to stabilise the economy and to try to ensure this year’s ambitious GDP growth target of 5.5% is met. In particular, fiscal stimulus will likely play an important role in supporting infrastructure investment, and possibly household consumption as well. More targeted monetary policy tools may be deployed to support small businesses and sectors heavily affected by the recent covid outbreaks.

But what is probably more important is for the Chinese government to find a proper exit from its current zero-covid strategy, which is imposing an increasingly heavy burden on the economy as the highly transmissible omicron variant spreads. The experience in Shanghai shows that it is hard to stamp out the virus entirely, even through the most stringent lockdowns, and that these lockdowns have an extremely high economic and social toll. So far, we have not seen any concrete evidence that the Chinese government is going to reverse its zero covid policy in the near term, but this is an extremely important area to watch for the rest of the year.

In conclusion, despite the strong Q1 GDP number, more recent data point to a broad-based slowdown in economic activity since March. We do not believe policy easing so far is sufficient to stabilise the economy in the near term. As such, our macro outlook for China remains cautious. We have decided to keep our full-year GDP growth forecast of 4.5% unchanged for the time being but recognise that there could be further downside risks to growth.