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China´s policy mix: "Proactive" and "prudent" in name, tightening in practice

Authorities in China are describing the policy mix in 2021 as “proactive” on the fiscal side, and “prudent” on the monetary side. However, China’s monetary policy already started to tighten in Q4 2020, going starkly in the opposite direction compared to the world’s other major economies. In fact, our proprietary credit impulse index shows that in 2020 China’s monetary easing lasted for less time than in 2008-09 (by three months) and represented only c.40% of the monetary stimulus implemented then: this is slightly more than the one third we had anticipated in mid-2020, but still relatively low. 

Both domestic and external conditions are ripe for Chinese authorities to tighten the policy mix: we estimate that the US super stimulus could boost China’s exports over 2021-22 by USD60bn (0.2% of GDP). At the same time, China’s own economic recovery is sufficiently strong (GDP growth at +2.3% in 2020, +8.2% expected in 2021), despite disparities. While retail sales contracted in 2020, labor market and household income indices suggest that the recovery of private consumption is likely to extend well into 2021.

The normalization of monetary policy is likely to happen at a faster pace than the fiscal policy. Indeed, we estimate that after 7.1% of GDP in 2020, fiscal support will decline to 4.6% of GDP in 2021, with less infrastructure investment. But this remains relatively generous compared to the past (2.9% on average in 2018-2019).

China’s policy tightening will aim at tackling financial vulnerabilities and asset price bubbles rather than consumer inflation. Indeed, China’s CPI grew by +2.5% y/y in 2020, compared to an official (non-binding) target of “around 3.5%”. Consumer inflation even turned slightly negative in the first months of 2021 – although this situation is unlikely to last for long (we expect +1.9% over 2021) and China’s producer prices are probably more relevant for policymakers and the rest of the world. The aim of China’s policy tightening is more about financial vulnerabilities and addressing the risk of overheating in the real estate and financial markets. China’s debt-to-GDP ratio rose to 285% at the end of Q3 2020, compared to 251% on average over 2016-2019. The real estate sector has been one of the main drivers of China’s post-Covid-19 economic recovery. Housing prices are still growing at a moderate pace compared to the past, but could accelerate as measures of inventories are declining quickly. Regarding the equity market, the CSI 300 total return grew by +18% in 2020 compared to +3.4% on average over 2016-2019, and the balance of margin long positions rose by +RMB262bn compared to an average yearly change of –RMB67bn over 2016-2019. This reveals some increase in short-term risk appetite and speculative behaviors.


Francoise Huang
Euler Hermes