China leading the world on the recovery

The post-virus recovery is already underway in China, and it may be at least one to two quarters ahead of the rest of the world.

ANZ Research’s industry-based forecast model suggests China’s gross domestic product (GDP) growth likely turned positive in the second quarter, growing 1.7 per cent year on year.

The recovery was spearheaded by both the manufacturing and services sectors, in which high frequency indicators have suggested a clear uptrend in April, May and likely in June.

Nonetheless, a reversal from the current accommodative stance is unlikely as China’s output gap remains negative. With the recent rally in equity markets and an increase in property transactions, authorities will likely become more concerned about rising financial risks.

Projection

ANZ’s China GDP projection is normally based on two models - one based on monthly PMI data and the other constructed from various readings of different industries.

However, the severe disturbance of the COVID-19 outbreak took monthly PMIs to historic lows in February and the first quarter, reducing the reliability of the first model.

Hence, ANZ Research has relied on the industry-based model to estimate China’s second quarter GDP growth.

China’s primary industry likely grew 1.2 per cent in the quarter after contracting 3.2 per cent in the first quarter. Compared with the significant slumps in secondary and tertiary industries, primary industry is the least affected by the global pandemic, as flagged by one report published by the Chinese Academy of Agricultural Sciences in June.

Food prices have come off their peaks to around 12 per cent, year on year, in the second quarter, from 20 per cent in the first quarter. This could suggest relatively more stable supply and demand conditions in the second quarter.

In addition, fixed-asset investment in primary industry has reversed its downtrend since the beginning of the second quarter, rising 6.9 per cent year on year on average in April and May, compared with a fall of 15.9 per cent in the first quarter.

ANZ Research estimates this industry’s GDP by using daily value added based on nominal GDP and working days in the second quarter, and then converting it into real terms by using agricultural prices. Based on our calculations, China’s primary industry GDP may have increased 1.2 per cent.

Having said that, the GDP share of primary industry has declined significantly to 7 per cent in 2019, from more than 10 per cent 10 years ago. Its growth has been stabilising at around 3 per cent to 5 per cent during this period, with a very limited contribution to overall GDP growth, ranging from 0.2 percentage points to 0.4 percentage points.

Tracking

ANZ Research has been tracking China’s manufacturing and construction activity using high-frequency data.

China’s heavy industry began to resume production in late March. One of the largest steel-makers in China has confirmed their plants kept producing even when located in a completely locked-down city. In the second quarter the situation significantly improved.

Construction activity also recovered. In the first five months of 2020 the decline in property investment narrowed to 0.3 per cent, compared with 3.3 per cent over the first four months. The figure in June may have returned to positive.

Statistically, China’s industrial value-added is a good predictor of GDP of the secondary industry. Based on our current forecast for June, together with the actual data in April and May, GDP of secondary industry is forecast to have expanded 3.5 per cent year on year in the second quarter after contracting in the first.

Bottomed out

China’s tertiary industry comprises more than 14 subsectors and accounts for 54 per cent of the country’s overall GDP.

During the past few months, ANZ Research has tracked service activities on a daily/weekly basis using various high-frequency indicators. The data clearly indicate services activity has bottomed out.

However, the level of activity has not recovered to pre-crisis levels as various lockdown restrictions or social distancing measures remain in place. For instance, Beijing reinstated a lockdown in June. Tertiary industry represented 87.8 per cent of that city’s GDP in 2019.

The services production index published every month since 2017 by the National Bureau of Statistics is a good predictor of the GDP of tertiary industry.

The index tracks GDP growth almost perfectly, with a correlation of 0.99. Growth turned positive in May after a three-month contraction. Expect the uptrend to continue in June.

As such, the GDP of China’s tertiary industry likely expanded 0.2 per cent in the second quarter, compared with a fall of 5.2 per cent in the first quarter.

Betty Wang is Senior China Economist at ANZ Institutional

This story is an edited version of a note from ANZ Research. Click HERE to read the original note.