China: Increasing self-reliance

The central committee of the Chinese Communist Party (CCP) met in Beijing during 26 and 29 October to discuss its 14th Five Year Plan (FYP), as part of its fifth Plenum meeting. The communique and press conference after the Plenum did not give many details on the FYP.

However, the main message seems to be one of increased self-reliance for China, especially in terms of technology. It is not quite clear what kind of technology China wants to develop exactly nor how that technology will be developed. Presumably, an increase in the domestic production of semiconductors will be a big part of this technology drive. Semiconductors are China’s largest import product (15% of total imports in 2019), they enable (and form a vital part of) other technologies such as 5G and artificial intelligence and quantum computing, and the semiconductor industry is one in which the US has explicitly tried to pressure China (for example by putting sanctions on SMIC).

Another important part of China’s overarching desire to become more self-reliant will be ‘Dual Circulation’. The idea behind Dual Circulation is that China will focus more on its internal market and less on the external market. Economic growth will be driven mostly by the Chinese consumer (‘internal circulation’), although international trade and foreign investment will continue to play an important role (‘external circulation’). Importantly, this implies that China will have to make trade-off between exports and domestic consumer demand since wages will have to up for the latter, which may make exports less competitive.

There was no explicit GDP growth target in the FYP. Rather, China aims to become ‘moderately developed’ by 2035, which contains an implicit growth target, although the definition is vague enough to not know how high that target really is. Instead of aiming for high growth, its seems the Chinese government is aiming for ‘quality growth’, a term which is being mentioned in various media (here and here), but without details on what quality growth means.

Overall, it is too early to say what the FYP means for China’s economic growth, its geopolitical relations and its trade relations. The shift towards self-reliance is clear, but how that will be achieved and to what extent remains unclear. We will do a more thorough analysis when enough details are known.

China’s National Bureau of Statistics (NBS) released third quarter GDP figures on October 19th, which came in at 4.9% y/y, worse than the Bloomberg consensus (5.5%), but better than we had anticipated a month ago (4%). A breakdown of the numbers shows that growth was mostly driven by industry and construction (6% y/y) and less by services and agriculture, which grew by 4.3% and 3.9% y/y respectively. The same picture arises when we look at monthly data. Industrial production for September was up by 6.9% y/y, but retail sales came in at a much lower 2.4% y/y (Figure 1). In addition, fixed asset investment were up 0.8% (ytd), yet the driver was public investments (4%), while private investment growth remained negative (-1.5%).

Together, these figures indicate that the economic recovery in China is driven by production more than by consumer demand and by government expenditure more than by private expenditure.

Going forward, we think that consumer demand will not pick up much more in the coming quarter, even though the latest Caixin services PMI has improved further to 56.8 in October (up from 54.8 in September). Covid-19 is still around, China is still being plagued by occasional outbreaks, for example in Xinjiang, which has led to an increase in containment measures again. The uncertainty surrounding the virus and the increased containment measures will keep a lid on the pace of the recovery.

Moreover, alternative indicators that do not rely on surveys, such as traffic volume (the number of passengers travelling by road, rail or air) are still pointing towards weakness in consumer demand. Traffic volume is not a direct indicator of consumer demand, but changes in traffic volume correlate well with changes in the services component of Chinese GDP (the correlation is 0.7 when calculated using quarterly percentage changes for the period 2005-2020). Traffic volume is still well below pre Covid-19 levels (Figure 2). The same holds more timely indicators such as box office sales at the cinema (-25% y/y in October) and electricity consumption in the services sector (-0.2% y/y in October). The picture painted by these indicators is one in which consumer demand is not ‘bouncing back’, rather it is slowly ‘crawling up’. All in all, we still think China’s GDP will grow modestly this year (1.7%), below the Bloomberg consensus of 2.1% (Table 1).

The external environment will not help China much either. Some of China’s main trading partners (the UK and Japan for example) are dealing with a second wave of coronavirus cases, which dampens demand for Chinese products (expect for goods such as protective equipment). In addition, tensions between China and Australia have anything but abated, with China adding lobsters and timber to a growing list of Australian products with import restrictions.

Meanwhile, the US presidential election seems too close to call at the time of writing. However, for the medium to longer term, we don’t expect a very different relationship between the US and China no matter if Biden or Trump wins. The tone of the debate may change, but the underlying problem will not. Tensions between the China and the US are here to stay in both cases because the root cause of these tensions are clashing ideologies, not economics.