China sets the stage for a new Stop-Go cycle. Tightening in 2020, says S&P

May 25, 2020

SINGAPORE -- China's decision not to set a GDP growth target for 2020 alleviates some risk of an excessive stimulus response to the COVID-19 economic shock, says global ratings agency Standard and Poors. However, China is still turning the dial on stimulus, and that stimulus could be swiftly withdrawn next year if the recovery continues.

 In a report released today, Shaun Roache, Asia-Pacific chief economist for S&P Global Ratings, says: "China is living through another stop-go cycle even though the stop, COVID-19, is different this time."

Even though Premier Li Keqiang declined to name a growth target at this weekend's National People's Congress sessions, he reiterated China's commitment to full employment - and swiftly achieving full employment needs policy support, says Roache.

"Our analysis suggests another large, credit-driven policy push is already under way. This will lift growth for a while: our forecasts are 1.2% in 2020 and 7.4% for 2021. But an inevitable tightening will follow in 2021.

"Difficulties in calibrating policies to balance growth and financial stability led to stop-go credit-driven business cycles in China's past.

"While not obvious from official GDP data, powerful upturns are followed by precipitous downturns that uncover pockets of financial stress and result in market volatility," he says. "Policies then swing back to loose, and so the cycle continues."

"The NPC has delivered a measured tone on stimulus. There were few surprises and a broadly consistent message on monetary, exchange rate, and housing policies at the just-concluded key sessions.

"However, on fiscal policy, the impulse is material, at about 3-4 percentage points of GDP including bond issuance not included in the budget.

"China's stimulus in this cycle is more targetted, with tax cuts and other relief for business that the Government estimates at 1.6% of 2019 GDP.

"China has also sharpened its monetary policy toolkit over the last decade, and is relying more on setting interest rates rather than dictating lending.

"Still, getting support quickly to the economy still relies on some old, reliable tools, including infrastructure spending.

"And our analysis of financial conditions indicate a fairly substantial credit-led stimulus is under way. As a share of trend GDP which smooths out the first-quarter decline, the change in new credit -- referred to as the credit impulse --has reached 4% of GDP. This is comparable to the last three cycles, though it is about half as large as the credit impulse of 2009.

"The risks involved in another credit buildup, especially given recent years' efforts to control economic leverage, is what could lead to hard stop in 2021.

"Weak spots in the economy, including overcapacity sectors or highly leveraged firms and households, could emerge." www.standardandpoors.com (ATI).