While mainland China heading for monetary easing, Hong Kong follows the Fed to raise rate
Market Strategist, Greater China
Summary: China’s 5.5% growth target for 2022 is a challenge. With a struggling property sector, rising energy and material costs and resurgence of COVID cases, China’s central bank needs to move fast to ease monetary policies and the Government shall roll out more infrastructure projects in the first half of the year. On the other hand, under the Linked-exchange-rate regime, Hong Kong followed the Fed to raise rate and has been mopping up liquidity in the banking system. President Xi’s call to minimize the socioeconomic costs of the Dynamic Zero-COVID policy is a positive development.
COVID related lockdowns and Fed’s rate hike taking the backseat. The comments triggered massive unwinding of shorts and market sentiments have significantly improved in the Hong Kong and mainland Chinese stock markets. COVID related lockdowns in mainland China and the Fed’s beginning of monetary normalization are taking a backseat for the time being. The U.S. Fed’s move to raise interest rate by 25bps overnight was as expected but the dot plot and the press conference were on balance hawkish. The Fed indicates in its dot plot 7 times of 25bp rate hikes in 2022 and 3.5 hikes in 2023, leading to a terminal Fed Fund rate of 2.75% in 2023 and 2024, above its long-run central tendency neutral rate of 2.3 to 2.5%. Fed Chair Powell played down the risk of recession. He remarked that labor markets were “tight to an unhealthy level” and pledged to adhere to the Fed’s price stability mandate. It is widely expected that the Fed will start quantitative tightening in the May FOMC.
Meeting the 5.5% growth target in 2022 is a challenge. During the China’s National People's Congress (NPC) which convened on March 5, 2022, Premier Li Keqiang delivered his Government Work Report. The around 5.5% GDP growth target was at the high end of economist expectations. CPI target is set at around 3%. M2 money supply growth and aggregate financing growth is targeted to be in line with nominal GDP growth. On the subject of the property sector, Li reiterated that “housing is for living in, not for speculation”. No property tax was mentioned so it should have been shelved. He remarked that the Government would satisfy reasonable housing demand and implement city-specific policies.
The budget deficit target is higher than the official target pf 2.8% of GDP once we include the RMB2.3 trillion transfers from SOE profits and the fiscal stabilization (which will bring the number to 4.6%). Tax cuts and rebates of RMB2.5 trillion in total are targeted (vs. RMB1.1 trillion in 2021). The tone of Li’s Report is in line with the Chinese Communist Party’s (CCP) Central Economic Work Conference last December: stabilizing the economy and engineering a sustainable recovery in growth on the basis of stability but no massive stimulus mentioned.
Meeting the GDP target seems challenging. The property sector, which accounts for 30% of the economy and a major drag to the growth last year, remains weak despite the fact that the Chinese Government has shifted from crackdown to a risk management modus operandi. Credit growth has been weak. In February, mortgage loan growth was negative. Land sales have come down a long way and will continue to be a constraint on local governments to roll out infrastructure projects given their reliance on the proceeds from land sales for revenues in their budgets.
Rising energy, industrial metals and grain prices in the global markets have worsened China’s terms of trade significantly. China is importing 70% of its crude oil, 40% of its natural gas, 90% of its soybeans and a high percentage of other materials, such as iron ores and so on. The sharp rises in the price of energy and materials are going to drag on China’s economic activities, corporate profitability and the Government’s budget. Under the current mechanism, when crude oil goes above US$130 a barrel, the Chinese Government will need to start subsidizing refineries to keep producing refined products.
While investors have temporarily thrown the fear about more lockdowns and supply chain disruption under China’s “Dynamic Zero-COVID” policy to the backseat, the fear may reemerge and linger for the months to come. The Chinese authorities have prided themselves for the Chinese economy’s impressive rebound from the pandemic before everyone else in 2021. The “Dynamic Zero-COVID” policy has been advocated to the country’s population as well as the rest of the world as demonstration of President’s Xi’s socialism with Chinese characteristics for a new era. It is politically difficult for the Chinese authorities to change course completely with the 20th Party Congress approaching.
Xi Jinping hosted a meeting of the Central Committee of the Chinese Communist Party’s Politburo on containment of the spread of COVID-19 yesterday. While he reiterated the rhetoric of stringent implementation of the policy of early detection, reporting, quarantine and treatment, the key takeaway from the press release was Xi’s remarks that “more effective measures should be taken to achieve maximum effect in prevention and control with minimum cost, and to reduce the impact on socioeconomic development as much as possible”. Immediately last night, Shenzhen announced that economic activities and public transportation will resume in 5 out of 10 regions of the city from today Friday March 18. Another manufacturing hub, Dongguan, also announced last night that the city will resume all public transportation starting today. This is a positive development but further spread of COVID cases remains a significant potential drag to the Chinese economy in 2022.
All eyes are on more infrastructure spending and monetary easing. With major economies in the worlds are facing high inflation, rising energy and commodity prices, monetary tightening and early signs of slowdown in economic activities, exports, China’s key growth driver last year, is having difficulty to do the heavy lifting this year on its own. To preempt much of the economic headwinds and risks, the Chinese authorities may accelerate the front-loading of infrastructure spendings in the first half of 2022. The People’s Bank of China (PBOC) is also likely to go into high gear to conduct a series of rate cuts and reduction in reserve requirement ratios when the window is still open. If the Fed’s monetary tightening and capital outflows from China starts putting depreciation pressures on renminbi in the coming months, it will become more difficult for the PBOC to ease. Apart from outflows from the Chinese equity markets, foreign investors sold US$35 billion worth of Chinese Government Bonds in February, the first time they turning net sellers in recent years.
Hong Kong follows the Fed to raise rates. While the PBOC is expected to accelerate its widely communicated tendency to ease monetary policies in mainland China, the Hong Kong Monetary Authority (HKMA) will follow the Fed to raise interest rates. Under the Linked-Exchange-Rate regime, Hong Kong adopts a currency board system for its currency and must keep the Hong Kong dollar’s interest rates close to those of the U.S. After the overnight move from the Fed to raise rate by 25 basis points, the HKMA followed suit this morning by raising the base rate 25 basis points higher to 0.75%. It is worth to note that the balances that banks have at the HKMA have been declining since September last year. In other words, the HKMA has already let the interbank liquidity to drain for quite some time. Despite the turmoil in the Hong Kong equity markets over the recent weeks and the embarrassing surge of COVID cases and mortality rate, the USDHKD 12-month forward point remains at a discount of 250 to 300 bps, showing no stress on Hong Kong’s Linked Exchange Rate regime so far.
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