Chinese Economy: Global Locomotive But Significant Risks

China’s economy, the second-largest in the world after that of the United States, is recovering from a sharp slowdown in the first quarter of the year. The first estimate of the annualized second-quarter GDP growth rate is +3.2% versus 2.4% expected, a strong reversal from -6.8% in the first quarter. The advance indicates that China’s early success in combating the coronavirus, along with positive results from China’s policy stimulus measures, have reversed the drag on the economy.

Early in the year, government spending was increased substantially, in part because of massive public health material and equipment needs. There were also VAT and income tax reductions, accelerated disbursement of unemployment insurance payments, waived social security contributions, and increased public investments. In sum, discretionary fiscal measures equal to 4.1% of GDP were provided in the first half. Looking ahead, significant further infrastructure spending is likely.

On the side of monetary policy, large liquidity injections early in the year were followed by liquidity support measures where needed. The reserve requirement ratio was lowered, as were the interest rate paid on excessive reserves and various policy rates. There were also measures to encourage lending to smaller firms and steps to limit tightening of financial conditions. As a result, credit growth has been robust and will provide a tailwind to industry, construction, and commodity markets in the second half.

Most other recent economic readings are encouraging. China’s Caixin Manufacturing PMI (purchasing managers index) for June reached a six-month high, while the Caixin Services PMI for June indicated that service sector activity (52% of the economy) expanded at the fastest rate for over a decade, as did the Composite Output Index (manufacturing plus services). Industrial production rose 4.8% versus one year ago. All categories of investment improved in June. The unemployment rate improved slightly – 5.7% in June versus 5.9% in May.

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Disclosure: Cumberland Advisors has holdings of the MCHI and ACWX ETFs in its investment portfolios. The author of this note has ACWX in his personal portfolio.

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