Focus on fiscal stimulus after China's unprecedented Q1 GDP contraction

Focus on fiscal stimulus after China's unprecedented Q1 GDP contraction
China was the first major economy to release data showing how Covid-19 has affected growth. The outlook may be dim, but there are promising signs ahead.

China, the world’s second biggest economy, contracted 6.8% year-on-year in Q1 2020, according to Friday’s (April 17) official data1, marking the first decline since 1992 when quarterly GDP records began. Fixed-asset investment plunged 16.1% in the same quarter, while retail sales in March slid 15.8% and factory output fell 1.1%2. 

China is the first major economy to release quarterly GDP data that reflects the impact of the coronavirus Covid-19’s impact on growth. The world is trying to estimate how long the economic shock will be, and market participants are closely tracking China’s post Covid-19 economic resumption. 

However, even though Friday’s numbers seemed to paint a bleak picture, Chinese market reaction has been fairly mild. We knew that going in Q1 would be the toughest economic quarter for China. The question is how quickly the economy can rebound stepping into Q2. 

Breaking down the numbers

The weak retail sales number shows that consumers are still cautious to spend despite the lockdown being removed in many places across China. This is the most worrying data point since consumption consists of around 60% of Chinese GDP3. It’s clear that consumer confidence will take longer to bounce back – an extrapolation that can be made across other geographies.   

There are some uplifting signs amid the historical contraction that we saw today.

For one, China’s industrial production print for March, at -1.1% versus a -6.2% consensus, is a clear beat, showing that manufacturing continues to ramp back stronger than expected. This trend is also reflected in the much better-than-expected March export number.

On the other hand, FAI registered a steeper fall than the consensus of -15%. I expect the FAI number to noticeably improve starting in the next quarter as state-owned enterprises (SOEs) finance new bond sales to accelerate investment projects.

Fiscal stimulus provides support

Looking ahead, the central government has responded in ways that could provide more support for economic growth. It has already introduced a stimulus package amounting to around 2.5% of GDP4. I expect Beijing to respond with another round of fiscal stimulus support of around 5% of GDP, after the NPC (National People’s Congress, China’s national legislature) meeting that is expected to take place later this month5. I expect the stimulus to be divided between traditional infrastructure (transportation), digital infrastructure (artificial intelligence, 5G, IT, internet) and measures to spur.

The way forward for China and the world

Although I think certain parallels can be drawn between China’s growth trajectory amid the pandemic and the rest of the world, there are many unique qualities to China such as its demographics and political system that should give investors pause about a direct comparison. 

Firstly, China’s unprecedented epidemic control to flatten the new infections curve and subsequent economic lockdown haven’t been successfully replicated in many other countries.

Secondly, Sino-US trade-war tensions faded with the signing of the Phase 1 agreement late last year, giving China’s economy had strong growth momentum prior to the outbreak. We saw that Chinese PMI in manufacturing and services rebounded at the end of last year with economic activity was about to pick up6.

Also, China hasn’t experienced the type of unemployment resulting from the pandemic that we have seen in other parts of the world, which suggests that its economy can, to a certain extent, pick up where it left off prior to the Lunar New Year in January. 

I expect that China will be the only major economy that will squeak out a positive GDP growth for 2020. Whether that will be 1% or 3% is very much dependent on the government’s policy – specifically any additional fiscal stimulus packages that will drive growth in the 2H.  

David Chao is Global Market Strategist (APAC) at Invesco.

^1 Source: Bloomberg, as of April 17, 2020.

^2 Source: Bloomberg, as of April 17, 2020.

^3 Source: World Bank data, as of April 17, 2020.

^4 Source: IMF Fiscal Monitor, Macrobond, Invesco. April 2020

^5 “China eyes rescheduled parliament for late April or early May: sources”, Reuters, March 16, 2020. 

^6 Source: IHS Markit, Caixin, April 2020.