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Power shortages another blow to global supply chains

  • We still don’t have enough data to judge the extent of the disruption to China’s factory output from power rationing with much certainty. But with supply chains already stretched, even a modest hit to output, which producers downstream might normally cover by dipping into inventories, could affect firms’ ability to meet orders. It’s therefore concerning that the number of ships idling outside Chinese ports has jumped again in recent weeks. (See Chart 1.) The initial catalyst for the spike was short-lived disruption to port operations from Typhoon Chanthu which hit China’s east coast on 12th September. But port congestion remaining very elevated more than two weeks later may be a sign that power rationing along the supply chain is interfering with ports’ ability to ship orders. Disruption is likely to worsen in the short-run given that the current shortage of thermal coal needed to meet power demand won’t be resolved overnight.
  • Coronavirus infections ticked up earlier this month but have now dropped back again.
  • Output & activity indicators suggests that headwinds to industry and construction are mounting.
  • Consumer spending appears to have rebounded after most virus containment measures were eased.
  • Business indicators suggest that high energy prices and supply shortages are likely to limit industrial activity.
  • Property indicators signal that China’s pandemic housing boom is over.
  • External indicators shows continued strength in foreign demand for Chinese goods.
  • Inflation indicators suggest that soaring energy prices are likely to push up factory gate inflation.
  • Monetary indicators suggest that the PBOC’s easing bias might halt the slowdown in credit growth.
  • Financial markets continue to sell off, this time due to the fallout from Evergrande and power shortages.
  • Hong Kong indicators suggest that the economic recovery will be held back until mainland visitors return.

Chart 1: Number of Container Ships Waiting to Berth at Chinese Ports (7-day average)

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Sources: Refinitiv Eikon, Capital Economics

Coronavirus

  • There have been renewed outbreaks in Fujian and Heilongjiang provinces in recent weeks (2). But these have been smaller and more localised than the flare-up over the summer, which was the most geographically dispersed since the initial outbreak last year. The latest outbreaks were driven by domestic transmission of the Delta virus. They are now being brought under control – cases have returned to being mostly in people arriving from abroad (3).
  • Apart from in these provinces, widespread movement restrictions have been lifted and high frequency data point to a rebound in travel. Intercity car journeys and subway passenger traffic are nearly back to where they were at the start of August while intracity road congestion has risen sharply (4). What’s more, tourism spending during last week’s mid-Autumn Festival was the strongest, relative to pre-virus levels, of any holiday since the start of the pandemic (5).
  • China’s vaccination campaign has lifted its pace of inoculation to one of the world’s highest. More than 70% of people are now fully vaccinated (6). But China will be slow to reopen its borders and allow unfettered travel. Admittedly, there are early signs that mass vaccination is breaking the link between infection and severe illness in China (7). But authorities are likely to stick with a zero-COVID strategy until they are confident that widespread infection wouldn’t strain healthcare resources.

Chart 2: New Confirmed COVID-19 Cases in China

Chart 3: New COVID-19 Cases in China*

Chart 4: Transport Activity (% of 2019 level, 7d ave.)

Chart 5: Tourism Spending* (2019 = 100)

Chart 6: Fully-Vaccinated Share of Population (%)

Chart 7: COVID-19 Cases in China

Sources: CEIC, WIND, OurWorldInData, Capital Economics


Output & Activity

  • The China Activity Proxy (CAP), our in-house alternative to GDP, suggests that output dropped back sharply in August (8). In seasonally-adjusted terms, our estimates point to the second-largest monthly decline on record. Efforts to contain the Delta variant were largely to blame, with August’s pullback mostly driven by a hit to services (9).
  • Containment efforts weighed heavily on in-person activity in August – intercity passenger traffic plunged to just 30% of 2019 levels (10). And while service sector electricity consumption remained strong, it fell by the most since last March. Meanwhile, tighter restrictions on borrowing among developers are driving a pullback in demand for construction materials which has led to a drop back in industrial output (11).
  • High frequency data (4) and the PMIs (12) point to a rebound in services activity this month. In contrast, steel output has continued to decline amid production curbs and softer demand from the construction sector (13). Alongside weak manufacturing PMI readings, this suggests that industry was softening even prior to the latest power shortages, which came too late in the month to be fully reflected in the surveys.

Chart 8: GDP & CE China Activity Proxy
(seas. adj., 2019 = 100)

Chart 9: CE China Activity Proxy by Sector
(seas. adj., 2019 = 100)

Chart 10: Passenger Traffic & Service Sector
Electricity Consumption (2019=100, seas. adj.)

Chart 11: CE Industrial Output Index
(2019=100, seas. adj.)

Chart 12: Official PMIs

Chart 13: Daily Steel Production by Large & Medium Producers (monthly ave., ‘000s tonnes, seas. adj.)

Sources: CEIC, Wind, Capital Economics


Consumer Spending

  • Household consumption returned to its pre-virus trend in Q2 (14). But the pandemic is still distorting spending patterns. Even prior to the recent Delta wave, people’s fear of being forced to quarantine if they cross paths with a confirmed case was holding back in-person consumer activity. Efforts to contain recent outbreaks have added to these distortions. Intercity travel saw a sharp fall last month (15). So too did restaurant sales (16). But goods retail held up better and online purchases remain especially strong (16).
  • The good news is that, aside from a couple of provinces, restrictions across most of the country have been eased. Early indicators suggest that consumer activity has largely rebounded as a result (4). High frequency data on cinema ticket sales show a return to pre-virus levels helped in part by new releases over the Mid-Autumn Festival (17).
  • If Q1 is any guide, temporary virus disruptions need not hold back overall consumption this quarter. But this will depend on income growth holding up and the household savings rate continuing to normalise (18). In both cases, the continued health of the labour market will be crucial. Encouragingly, there is little sign of a deterioration in the labour market – the unemployment rate held broadly steady in July and August while the official PMIs suggest that, outside the manufacturing sector, hiring picked up in September (19).

Chart 14: Household Consumption (constant prices)

Chart 15: Intercity Passenger Traffic (% of 2019 level)

Chart 16: Retail Sales (Dec. 2019=100, seas. adj.)

Chart 17: Daily Cinema Ticket Sales (% of 2019, 7d ave.)

Chart 18: Household Savings Rate (%)

Chart 19: Official PMIs - Employment

Sources: CEIC, Wind, Capital Economics


Business

  • Although industrial sales have remained strong, profits have been dropping back (20). A combination of supply bottlenecks and higher costs of raw materials are mostly to blame. Power plants have been hardest hit (21), as price controls have left them unable to hike electricity tariffs in the face of soaring thermal coal prices. This gives them a strong incentive to ration power which is likely to weigh on industrial activity.
  • What’s more, a dearth of shipping containers means freight rates out of China are on average triple what they were pre-pandemic on most major shipping routes (22). The latest regional Delta wave is putting additional strain on supply chains. Disruptions to chip supply from Malaysia are reportedly holding back Chinese car production. The monthly data don’t yet show the impact of electricity shortages in late September, but power rationing may have contributed to keeping the number of ships idling at anchorages off China unusually high (23).
  • Elevated capacity utilisation rates (24) have led to a boom in manufacturing investment. But business surveys suggest that firms are starting to pare back investment intentions amid growing concerns over the economic outlook (25).

Chart 20: Industrial Revenues & Profits
(Dec. 2019=100, seas. adj.)

Chart 21: Profits of Electricity & Heating Producers (RMBbn, seas. adj.)

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Chart 22: % Change in Total Container Sea Freight Costs from China by Destination (Change from 2018-19 Ave.)

Chart 23: Number of Container Ships Waiting to Berth at Chinese Ports (7-day average)

Chart 24: Industry Capacity Utilisation Rate (%)

Chart 25: Investment Intentions & Manufacturing FAI

Sources: CEIC, Wind, Refinitiv, Capital Economics


Property

  • China’s recent property boom has come to an end, with the prop to demand from excess savings waning and property sales falling back to pre-pandemic levels in August (26). Mounting concerns among homebuyers about the financial health of developers have pushed down home sales further in recent weeks (27). As a result house prices have levelled off recently, and are now starting to decline (28). Downward pressure on prices partly reflects discounts offered by cash-strapped developers to drum up presales in an effort to weather regulatory restrictions on their borrowing (29).
  • The central concerns of property policy now appear to be the level of housing costs and developer leverage. Although officials may relax controls aimed at curbing housing demand, which remain tight (30), it seems unlikely that rules on developer financing will be eased. With the screws being tightened, developers are turning more cautious. The recent pullback in their land purchases (27) suggests that property starts will continue to decline and weigh on overall construction activity before long (31). More importantly, it appears that housing demand is in the early stages of a structural slowdown. Relaxation of regulatory controls wouldn’t change this fundamental constraint.

Chart 26: Residential Property Sales (SA, million sqm)

Chart 27: Real Estate Activity (vol., % of 2019)

Chart 28: Second-hand Home Listing Price
(4th Jan 2015 = 100)

Chart 29: Developer Financing (RMB trn, seas. adj.)

Chart 30: Average Mortgage Rate minus Average Lending Rate (Basis Points, latest = Q2)

Chart 31: Real Estate Construction (seas. adj.)

Sources: CEIC, Refinitiv, Wind, Capital Economics


External Trade

  • Export volumes have levelled off in recent months but remain exceptionally strong (32). This reflects in part a scramble among overseas retailers to replenish inventories of consumer goods such as electronics, furniture and recreational products which have been in high demand during the pandemic (33).
  • In contrast, import volumes have dropped back somewhat (32). This largely reflects fewer inbound shipments of semiconductors and other electronics components amid supply shortages (34), which have been made worse by the recent wave of infections across Asia. In contrast, grain imports remain very strong thanks to higher demand for soybeans amid the recovery in pig stocks following African Swine Fever. And while imports of industrial commodities have softened since the start of the year, they picked up strongly in August. The goods surplus remains large but has narrowed since the turn of the year. (35).
  • Industrial export sales (a measure of export orders) suggest that foreign demand remains buoyant (36). But there is limited potential upside to exports given that Chinese ports are already operating at full capacity. Instead, the risk is that demand drops back as global consumption patterns normalise coming out of the pandemic. This would weigh on imports too given that around a third of inbound shipments feed into China’s export sector (37).

Chart 32: Goods Trade ($bn, seas. adj., 2010 prices)

Chart 33: Exports ($, Dec. 19 = 100, seas. adj.)

Chart 34: Import Volumes (Dec. 19 = 100, seas. adj.)

Chart 35: Goods Trade Surplus ($bn, seas. adj.)

Chart 36: Exports & Industrial Export Sales
($, SA, Dec-2019=100)

Chart 37: Imports by Use ($bn, seas. adj.)

Sources: CEIC, Refinitiv, Capital Economics


Inflation

  • Producer price inflation hit a 13-year high in August (38). A low base for comparison kept the headline figure elevated even as m/m price gains dropped back from the rapid pace seen earlier in the year. The rally in industrial commodity prices continues to explain the bulk of m/m price rises. Encouragingly, m/m price gains appear to be slowing for consumer durables and electronic goods, suggesting that supply shortages in the sector may no longer be as severe as a few months ago (39).
  • Weekly data show that producer prices continued to climb in September due to the surge in global energy prices (40). This will likely push up producer price inflation further in the near-term. But we doubt prices will keep rising for much longer given the impending slowdown in construction and industrial activity. Base effects will also start to exert more downward pressure on the headline rate at the turn of the year.
  • Consumer price inflation has dropped back again recently (41). Food prices have been the key disinflationary force. Pork prices have more than halved since the start of the year as pig stocks recover from the African Swine Fever outbreak and have continued decline in recent weeks (42). Meanwhile, an improving labour market had allowed core inflation to rebound. But that may have run its course now that the unemployment rate appears to be levelling off (43).

Chart 38: Producer Prices

Chart 39: PPI – Durable Consumer & Electronic Goods
(% m/m)

Chart 40: Weekly Producer Prices (100 = 23rd Feb. 2020)

Chart 41: Consumer Prices (% y/y)

Chart 42: Pork Price (100 = Jan. 2018)

Chart 43: Unemployment & Core Inflation

Sources: CEIC, Refinitiv, Capital Economics


Monetary

  • The PBOC flagged a desire to lower borrowing costs when it reduced the required reserve ratio (RRR) for most banks by 50 basis points in mid-July (44), but there has since been little follow-up. The central bank has not made any downward adjustments to its policy rates (45). And it has kept market interbank rates broadly stable (46).
  • Given that the economy’s rebound has gone into reverse and there are mounting concerns over the outlook for the property sector, pressure to relieve the financing strains of indebted borrowers and support the housing market is intensifying. We think policymakers will step in to make the deleveraging process more manageable, by pushing down interest rates and relaxing property purchase controls. We expect policy rate cuts as soon as October, alongside further RRR reductions.
  • This easing bias means that credit growth, which has reversed all of last year’s jump, will likely halt its decline in the coming quarters (47). But a sharp rebound in borrowing doesn’t appear imminent. Most of the jump in new credit last year was due to the relaxation of the quantitative controls on lending, which have since been reversed (48), helping to curtail loan growth (49). We suspect that the bar for embarking on another round of credit-led stimulus is high given the leadership’s concern over debt levels.

Chart 44: Required Reserve Ratio (%)

Chart 45: Loan Prime Rates and MLF (%)

Chart 46: PBOC & Interbank Rates (%)

Chart 47: Aggregate Financing*

Chart 48: PBOC Banking Survey (diffusion indices)

Chart 49: RMB Bank Loans (Outstanding, % y/y)

Sources: CEIC, Refinitiv, Capital Economics


Financial Markets

  • The Hang Seng Index has continued trending down in recent weeks, as have stocks listed in Shenzhen. In contrast, those in Shanghai have traded sideways (50). The worst performers onshore have been material stocks, along with consumer and tech stocks (51). This appears to reflect a cocktail of investor concerns about regulatory risks, the prospects for the property sector and the fallout from the latest energy shortages.
  • Much of the focus in credit markets has been on Evergrande. Domestic investors appear relatively relaxed about the contagion risks, with onshore high yield bonds holding up reasonably well. In contrast, the sharp sell-off in offshore high yield bonds points to greater concerns among foreign investors (52). While most other developers don’t appear to be on the brink of bankruptcy, we do think corporate bond defaults will rise as the economy slows (53), especially given that officials remain keen to impose more discipline into credit markets
  • The renminbi has remained broadly steady against the US dollar recently and has continued to appreciate in trade-weighted terms (54). The weaker offshore rate relative to the onshore one (55) suggests some quasi-official intervention may have contributed to the renminbi’s strength in recent weeks.

Chart 50: Equity Indices (20th Jan. 2020 = 100)

Chart 51: CSI 300 (20th Jan. 2020 = 100)

Chart 52: China High Yield Corporate Bond Indices
(Jan. 19 = 100)

Chart 53: Onshore Corporate Bond Defaults (RMB bn)

Chart 54: Renminbi Exchange Rate

Chart 55: CNH-CNY Spread (basis points, 7d ave.)

Sources: CEIC, Refinitiv, Wind, Capital Economics


Hong Kong

  • Hong Kong’s economy contracted in seasonally adjusted q/q terms last quarter, although a lower base kept y/y growth very high. The pullback in output was largely driven by softer exports which looks to have rebounded slightly this quarter (56). Encouragingly, there are signs of a pick-up in consumer activity, while fiscal policy remains relatively supportive too (57).
  • But the boost to the economy is likely to be limited. Retail sales are already back near pre-virus levels but remain depressed relative to pre-protest levels due to the absence of mainland visitors (58). A full and lasting recovery will only be possible after borders reopen, and tourists return.
  • The official priority is to reopen the border with the mainland. That probably precludes reopening to the rest of the world as long as China is sticking with its zero-COVID approach. To attract mainland visitors, the “Come2HK” scheme which allows non-residents to arrive from China without needing to quarantine started on 15th September. But daily arrivals have remained low (59) since China hasn’t lifted its quarantine requirements for those returning. We now forecast growth of 7% this year (from 8% previously). Finally, vaccination rates remain woefully low among the senior population in Hong Kong (60), despite aggregate vaccination numbers approaching those in other rich economies (61).

Chart 56: Hong Kong Exports (%3m/3m, SA)

Chart 57: Hong Kong Budget Balance (% of GDP)

Chart 58: HK Retail Sales Volumes (SA, May 2019 = 100)

Chart 59: Hong Kong Passenger Arrivals
(24th Jan. 2020 = 100, 7d ave.)

Chart 60: Hong Kong Vaccinated By Age
as a Share of Eligible Population (%)

Chart 61: Total Coronavirus Vaccine Doses Administered Per Hundred People

Sources: Refinitiv, HK Govt Vaccine Dashboard, OWID, CEIC, CE


Julian Evans-Pritchard,Senior China Economist, julian.evans-pritchard@capitaleconomics.com
Sheana Yue, Assistant Economist, sheana.yue@capitaleconomics.com

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