Emerging Markets Outlook: China’s Economy Rebounds, But Equities Face Concentration Risk

The Chinese economy continues to recover from the COVID-19 shock and is now close to pre-pandemic output levels. This is quite a significant feat, given the depth of the downturn in the first quarter, and the fact that the International Monetary Fund expects other large countries to not return to pre-COVID levels until 2022. China’s economy has been supported by several key factors:

  • A more successful experience with containing the second and/or third waves of COVID infections. This has allowed the economy to reopen at a faster pace.
  • A significant amount of fiscal and monetary stimulus. The former has led to a large amount of government bond issuance, which has been funneled into infrastructure projects. The latter has kept borrowing rates low and provided significant amounts of liquidity to the Chinese economy.
  • Export-oriented industries benefiting from the reopening of the global economy.

The consumption side of the nation’s economy has played catch-up to the production side of the economy. This is a particularly important development when considering the outlook for government policy, given the Chinese government’s focus on the concept of dual circulation. This reflects the desire of the Chinese government to further strengthen the domestic demand and accelerate the economy’s shift away from being export and capital-heavy economy to a consumption-based economy. This is essentially one of the key transitions that is needed to ensure that China does not fall into the middle-income trap.

Fiscal policy will remain supportive

The Chinese government and central bank have already been discussing when to start reducing the amount of stimulus. We think what’s likely to happen is that we’ll see a continuation of the hand-over from monetary policy to fiscal stimulus. The PBoC  (People’s Bank of China) governor, Yi Gang, has expressed concern about the level of borrowing that has occurred in response to the lower interest rates and increased liquidity—suggesting that further monetary easing is unlikely. However, the removal of support is likely going to be delayed until at least the end of the year, given the need for liquidity from the banks in the final two months of the year.

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Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.

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