Macroeconomics
China’sGDPTarget:WhenLowerMeans(Much)Higher
7 mins
Earlier this month, the Chinese government set the much-anticipated growth target for 2022 at “around 5.5%”. While lower than the “above 6%” target for last year, peculiarities in China’s GDP measurements mean the 2022 target is, in fact, much more ambitious. In this blog, we disentangle the signal from the noise in China’s economic data and discuss the government’s likely response to the mounting challenges facing China’s economy.
The unprecedented nature of the pandemic lockdowns has stretched the ability of standard macroeconomic statistics to properly reflect real-time economic trends. One key problem is the so-called “base effect”, meaning economic data that are reported on a year-on-year basis get distorted because of irregularity in the economic performance 12 months prior. In China, base effects are particularly acute in the growth statistics as they are measured in annualized averages, thus carrying over data points as old as 24 months.
Sifting Signal from the Noise
The usual antidote to base effects is to incorporate higher-frequency data with shorter lookback windows, typically quarter-on-quarter data that are seasonally adjusted. Indeed, GDP data in the U.S. and the euro area are typically discussed in terms of seasonally adjusted rates of growth which are free of base effects. While these data are also available in China, they are unfortunately inconsistent with reported annual data. Forcing consistency, though, permits us to disentangle the base effects from genuine, within-year economic growth in China since 2018:
Figure 1
Disentangling the Carryover Effect from Actual Growth in China's GDP Data
Haver Analytics, PGIM Fixed Income.
Figure 1 distinguishes average GDP growth into 2 components. First, the so-called carryover effect — i.e. the difference of the prior year’s 4th quarter annualized GDP compared to that year’s average GDP — and second, the additional growth that is incurred in the current year. In periods of steady growth, the relationship between these two components is fairly stable. However, significant within-year economic shocks can introduce significant distortions to GDP data. The “first-in-first-out” recession experienced in China during COVID certainly fits the pattern: The massive contraction in the first quarter of 2020 was followed by an equally impressive rebound in the remainder of the year. This means that annualized GDP in the fourth quarter was 6.3 percent higher than the 2020 average, imparting a very large carryover into 2021’s average GDP growth. Thus, even though the economy grew at a record-low pace of 1.3% within 2021, average headline growth clocked in at 8.1%, easily higher than the target of “above 6%.”
The latest growth target announced this month sets up a mirror image. Given the increasingly weak data throughout 2021, the minimal carryover in the numerator means that the government’s 5.5% growth target — seemingly a stepdown from last year — actually implies a massive growth acceleration to the tune of 4.7%, almost triple what was observed last year and the fastest within-year growth since 2012. Such a rosy growth target also comes under the backdrop of a sharp slowdown in real estate. Moreover, export growth, which had reliably underpinned economic momentum since the second half of 2020, is likely to decelerate as global growth slows amid the rapid withdrawal of monetary and fiscal stimulus expected worldwide, not to mention risks from the recent geopolitical stress and surge in commodity prices.
Considering the vast gap between the underlying growth trajectory and the official target, stimulus measures undertaken thus far appear rather underwhelming. We expect China to significantly step up support for the economy through more short-term liquidity injections, interest-rate cuts, and reductions in the reserve requirement ratio. On the fiscal front, while the narrowly defined headline fiscal deficit target was set at 2.8% of GDP, down from last year’s 3.2%, the government will likely significantly increase the augmented fiscal deficit ratio (as defined by the International Monetary Fund), a more comprehensive measure including local-government and off-budget spending, to above 18 percent of GDP from 16.5% in 2021. Finally, the government will likely need to provide additional support for the property sector, which accounts for almost one-third of China’s economy and is still reeling from a full-blown credit crisis.
Conclusion
Still, China’s eventual growth in 2022 may well come short of the target, as even the most comprehensive stimulus package takes time to percolate into the real economy. We also see a substantial likelihood of another stimulus overshoot as policymakers will be tempted to incrementally add stimulus as prior measures seemingly fail to lift growth given inherent lags. While such a large overshoot of policy easing may be a welcome relief to investors’ current stress about global recession risk, further down the road it will no doubt raise renewed questions on China’s debt dependence, the rinse-repeat leverage cycles, and ultimate the sustainability of China’s growth model.
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