Coronavirus recovery: China still on course for monetary policy tapering despite new Covid-19 outbreaks

A new wave of Covid-19 cases hit some sectors but not all, as industrial activity and consumption remained strong over the Lunar New Year holiday
The People’s Bank of China is expected to stick to its plans to normalise policy while proceeding carefully to avoid introducing new risks to the recovery

Aidan Yao

Published: 3:45pm, 24 Feb 2021

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Growth momentum moderated in early 2021 after the Chinese economy ending the Year of the Rat on a high note. A new wave of Covid-19 hit the northern part of the country, creating heightened alerts and renewed social restrictions before the Lunar New Year.

Manufacturing and service-sector growth weakened visibly in January, with purchasing managers index levels falling from multi-year highs. Nationwide transport data showed that pre-holiday travel volumes were more than 70 per cent below normal levels as migrant workers were encouraged to stay put and people refrained from taking long-distance holidays.

The renewed outbreak and associated social restrictions are expected to hold back recovery in some service activities and household spending, though only temporarily.

However, the virus outbreak has not had an equal impact on all sectors. With migrant workers staying in towns and cities for the holiday, many businesses and factories were able to remain open. Daily industrial activity data remained solid.

Even though inter-regional travel was curtailed by tighter restrictions, traffic congestion within major cities was at or above normal levels.

02:54

Lunar New Year in China: Locals celebrate the start of the Year of the Ox

With people staying in cities, urban consumption benefited from a release of purchasing power during the holidays. Online retail, car sales and restaurant revenue all grew substantially. Despite capacity restrictions at cinemas, box office sales broke records – at over 7.8 billion yuan (US$1.21 billion) and almost 160 million movie-goers – up 23 per cent from the same period in 2019.

Anecdotal evidence from courier firms, which remained operational during the Lunar New Year because of the availability of labour, also showed a surge in orders due to increased online shopping and gift shipping. These positives are expected to offset the shock to tourism and transport, limiting the overall impact of the virus resurgence on GDP growth.

Another reason for staying positive is that the outbreak appears to have been short-lived. Local infection cases fell to zero just before the Lunar New Year and have remained very low since then. Beijing ordered cities and provinces that were subject to restrictions to avoid imposing any new measures before and during the holidays.

With the situation now largely under control, the next step is to gradually roll back travel bans, allowing mobility to resume and the affected sectors to return to normal.

01:31

‘Fire-breathing dragons’ dance at Lunar New Year celebration in China

Overall, despite the latest wave of the coronavirus, my forecast for full-year growth remains unchanged. However, it might affect the quarterly GDP profile relative to previous expectations, with slightly weaker first-quarter growth followed by a rebound in the second quarter.

The brief interruption to the recovery is not expected to change the People’s Bank of China’s (PBOC) monetary policy outlook. Despite a brief scare about a liquidity shortage before the Lunar New Year – driven largely by mismatched expectations between the market and the central bank – investor sentiment calmed down after the central bank injected liquidity, driving interest rates back to more normal levels.

The January credit data also showed no obvious sign of monetary tightening, with strong growth in bank loans offsetting weak local government bond issuance because of a lack of front-loading quotas this year. With muted inflation and the yuan staying firm, there is little urgency for the central bank to take a sudden turn towards monetary tightening.

That being said, people should be under no illusion that last year’s ultra-accommodative policy stance will last forever. The PBOC has made abundantly clear its desire to normalise policy through recent speeches and the creation of a tight balance in interbank liquidity via open market operations.

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In their first such operation after the Lunar New Year, the central bank wasted no time in withdrawing 260 billion yuan of excess liquidity that was injected before the holidays.

All this suggests the PBOC is willing to look beyond the short-term disruptions caused by Covid-19 and is staying the course on exiting emergency policy settings.

Overall, the latest developments have reinforced my view that monetary policy is on a steady path to taper in 2021, but the PBOC will manage this process carefully. I expect no increases in reserve requirement ratios or interest rates this year, but targeted tightening to rein in financial imbalances and leverage risks – in the property market, for instance – can be intensified.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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