China’s rate rise puts recovery at risk, says S&P

August 18, 2020

SINGAPORE -- Interest rates have risen as China's better-than-expected second quarter GDP growth lifted markets, according to S&P Global Ratings, which says that underlying inflation continues to keeps fall, causing an even larger rise in real rates. S&P believes a climb in real interest rates may throw China's recovery off course "just as it should be gathering steam".

In a report released today, S&P Global Ratings Asia-Pacific chief economist, Shaun Roache, said: "China's economic data for July provides more indication the recovery remains unbalanced and reliant on extraordinary policy support.

"China's industrial sector has been remarkably resilient, largely aided by rising global demand for technology and medical equipment arising from the global pandemic."

Stimulus spending had lifted infrastructure investment and the upstream industries that fed it, he said. And rising household savings and a desire for assets perceived as a reliable store of wealth had lifted China's property market.

"China's consumers are lagging behind in this recovery. Five months after COVID-19 cases peaked, retail sales are still below the levels for the same period last year," Roache said.

"Until COVID-19, monthly retail sales had been growing at close to 8%, year-on-year.

"The other soft spot is investment in the manufacturing sector, which private firms have dominated in recent years. Compared with the same month a year ago, manufacturing investment fell about 1% in July.

"The good news is that investment in the electronics and medical-related sectors is strong, reflecting robust global demand for these types of goods.

"The dynamics behind this unbalanced recovery remain the same, in our view. Social distancing--enforced or voluntary--suppresses demand for business and consumer services, holding back jobs."  

Roache said investors had turned to equities and shunned Government bonds, often seen as a safe haven, causing their yields to rise and pushing up yields on corporate bonds.

At the same time, markets had interpreted the recent rise in short-term repo rates -- which were heavily influenced by central policies --as a sign that policymakers were comfortable pulling back some monetary stimulus.

Rising rates also reflected an abiding tension in the central bank's wish to lower borrowing costs while guarding against financial risks. (ATI).