Morgan Stanley
  • Thoughts on the Market
  • Dec 1, 2020

China 2021: The Consumer Roars Back

Andrew Sheets and Robin Xing


Andrew Sheets: Welcome to Thoughts on the Market, I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley.


Robin Xing: And I'm Robin Xing, Chief China Economist for Morgan Stanley.


Sheets: And on this special episode of Thoughts on the Market, we'll be discussing the 2021 outlook for China's economy and how that outlook could affect markets. It's Tuesday, December 1st, at 12:30 in London.


Xing: And 8:30 pm in Hong Kong.


Sheets: Robin, let's start with your outlook for China's economy. What do we think growth could be next year in China? And where do you think that puts us relative to consensus?


Xing: The key really comes down to what's going to drive China's next leg of recovery. This year is largely the manufacturing sector because they normalized the factories, the export of capacity ahead of other economies. But next year, with the global economy on track to resume its pre-COVID trajectory by second quarter 2021, we think China will be largely relying on its domestic demand. So what's different between our view on China's growth and the consensus lies in our assessment of private sector risk appetite. We think China is moving to a more self-sustaining phase of the recovery. On the contrary, I think the consensus is more focused on the impact of a potential tightening from China. And what if China is going to lose export market share once other countries have resumed production? We are aware of these concerns, but we think this still very strong global recovery plus the private sector confidence normalization would be more than enough to offset these dragging factors. So even if China is losing some market share in global exports slightly, its manufacturing and the consumption will still hold up at a reasonable level next year.


Sheets: And so, Robin, if I put that into numbers, what sort of GDP growth are you expecting from China next year?


Xing: A 9% real GDP growth up from 2.3% this year. I think our base case is probably the bull case for many other brokers. And again, that's based on our view on a very strong recovery in the private consumption to probably double digit growth in retail sales. Plus the manufacturing capex could finally recover from -3% this year to 6% growth for next year.


Sheets: So I'd like to drill into that rebound in private consumption because as you mentioned, that's a transition of the growth outlook. I think when a lot of investors think about China, they think about manufacturing, they think about exports, they don't think as much about the domestic consumer led economy. And so, you know, if you think about, what's going to drive that and what sectors within China's economy are going to benefit most from that rising consumer demand, how do you see that playing out?


Xing: I think there is a lot of investor debating on if the recovery will be sustainable. We see three drivers behind our narrative on a consumption recovery. First is this partial unwind of excess savings. If you look at the Chinese household savings in a normal year, they save 30% of their income. But this year, the savings rate came in very high at 37% in the first three quarters. But next year, that excess saving, which is the equivalent to 6% of China's annual consumption, could be released. And secondly, it's about the recovery of job market. Now we have a very strong manufacturing sector benefiting from the global demand recovery. That usually will lead China's wage growth by around three to six months, given the spill over to the services sectors and also the continued normalization in some social interaction based services sectors with the equation between the virus and the economy continue to improve. And finally, we think there is some further room of this consumption reissuing. We mentioned in previous episode of Thoughts on the Market. That's roughly more than 260 billion dollars per year. It's a lot of sectors are lagging behind this year, like the travel, tourism, entertainment, lodging, catering. I think that's the sectors which will benefit a lot from this unleash(?) of excess savings next year.


Sheets: So, Robin, I think that is interesting because I can imagine that one of the concerns investors have is that if Morgan Stanley is right on our growth forecasts, if you're right that we're going to see 9% GDP growth next year, then wouldn't that cause authorities in China to start tightening policy in response to that strong growth and that tighter policy would then create other challenges?


Xing: I think that brings us to what type of policy framework China has been operating on monetary, on credit since 2016. We call it counter cyclical policy. They have a big picture target to contain the debt to GDP ratio, the macro leverage they call it, because of the concerns on financial risks. So in a normal year, they try to set credit growth target consistent with the nominal GDP growth so in that way they can manage the debt to GDP ratio. However, this year was quite unique with covid, with the recession in the first quarter, the provided stimulus, credit growth was at elevated level. Now, as we mentioned, because this private sector confidence is coming back on the back of a strong global demand and the domestic consumption recovery. Now, that provided room for this countercyclical tightening to rein in leverage and the financial risks. So that's why they are going to tighten. So first in, first out and first exit, that's what we call for China's growth and policy framework, this and next year. So it's like a deja vu of 2017 when a synchronized global recovery gave China some confidence tightening on credit growth, but it's private sector dynamics remained quite healthy, continued to lead the recovery trajectory back in 2017. So we think it's pretty much similar to what happened that year. And finally, the tightening will likely be in the form of financial regulations and some fiscal tightening so that they can bring down credit growth to a level consistent with nominal GDP.


Sheets: We're looking at a new U.S. administration coming in January. How do you think trade and exports might play out in 2021 and beyond? And also, I'd be curious when you talk to investors in china, what do they think will change or won't change with a Biden administration?


Xing: Well, that's the question we have been asked many times and no doubt an important one for global economy, for China. A lot of the investors in Asia, they expect the nontariff barriers between the two countries around critical technology, around security, geopolitical issues-- they will largely continue. That being said, investors also believed the new administration could take on a different approach and policy tone towards things like trade tariffs. I would say if we take a step back, all this discussion among investors about the U.S. and China and the new administration is still pretty much fitting in our house(?) view of a multipolar world. That is the U.S. and China will increasingly compete directly in multiple sectors such as tech, security, health policy, financial market, while the rest of the world attempts a balancing act. So I would say the multipolar world thesis is still our, you know, key view, even with a new administration in the US.


Xing: So Andrew, we know from China "first in, first out" story in 2020 to a broader EM recovery in 2021. Now we see growth next year to converge. Basically, the economies lagged in countries like in South Asia, in Southeast Asia, they may catch up, narrowing the growth divergence between North and South Asia. So what will the impact be on our equity market?


Sheets: I think, you know, you have seen China be a relative economic outperformer this year because of that kind of first in, first out dynamic with the virus. And also its equity market has been a very strong performer because its equity market has been very geared towards many of the large technology companies that have been leaders this year. So, you know, I think if we're thinking about 2021 looking more normal, looking broader based, seeing that global expansion broaden out and also seeing the equity rally broaden out, my sense is that you could see some of that leadership transition and that the market would look towards economies that have been bigger underperformers this year turning into leaders next year. And so I think that could be an interesting place to look, again, as we look to see kind of what that next leg of global growth looks like.


Xing: So the last question for you, what other trades are you watching with respect to China?


Sheets: Well, so the one other thing I think that's worth mentioning is China's bond market, which I think is interesting, both from an investment standpoint and kind of an international trade standpoint. So in theory, you know, Chinese government bonds are kind of interesting that they're starting off with a significantly higher yield than bonds in other markets. And also both bonds and stocks in China have relatively low correlation to equity markets and bond markets elsewhere. You know, to your earlier question about, you know, kind of China becoming a little bit disconnected from the global economy, I think its market is also a little bit disconnected. It can kind of sometimes be on its own program, for better and for worse. And from an investor standpoint, that can be attractive. Right? We're all looking for less correlated assets in a portfolio, uncorrelated exposure in a portfolio. And so to the extent that China's stock market or China's bond market is going to be driven by factors that are domestic and not global, then that could mean that they can provide pretty attractive diversification benefits to a global portfolio.


Sheets: Robin, thanks again for taking the time to talk.


Xing: Great speaking with you, Andrew.


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China’s consumers could emerge as a key GDP growth driver in 2021, fueled by COVID-19 vaccine availability, a recovery in the job market and pent-up savings by households.

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