The Chinese People’s Political Consultative Conference (CPPCC) and the National People’s Congress (NPC) – the so-called Two Sessions – will kick off this weekend (starting on Saturday, March 4 and Sunday, March 5, respectively). During the one-week long “Two Sessions” event, the Government Work Report delivered by outgoing Premier Li Keqiang and the 2023 fiscal budget proposed by the Ministry of Finance will be discussed and approved by the NPC. Because this year’s Two Sessions coincide with the once-in-a-decade personnel reshuffling at the State Council as well as all the ministries under the State Council, they carry special importance.
The TL/DR summary of what to expect, comes from Bloomberg’s in-house China expert Tom Orlik who writes that the Congress/Conference will see a further direct concentration of economic and financial power under the CCP:
While the assumption among many China watchers is that the changes represent a further tilt away from markets that is ultimately bad for growth, recent moves to end Covid Zero restrictions, boost support for the property sector and seek better ties with the US suggest that investors shouldn’t rush to conclusions. The potential positive way of looking at the looming personnel and organizational changes is when Xi has a team around him who he’s familiar with and who he trusts. Perhaps there’s just some more space to get some good things done, to make some pragmatic decisions.
For those less pressed for time, here is a more detailed summary on what to expect at the Two Sessions, as excerpted from a recent note by Goldman analyst Hui Shan
Three things to watch: growth target, fiscal budget, and personnel changes
On the first day of the NPC (Sunday, March 5), the sitting premier Li Keqiang will deliver his last Government Work Report (GWR) which will contain the government’s various economic targets, most important of which is the GDP growth target. Goldman’s baseline expectation is a relatively conservative “around 5%” GDP growth target, although the bank forecasts actual GDP growth to be 5.5% in 2023. Last year’s miss on growth target (3.0% actual growth vs. “around 5.5%” target) may cause policymakers to set a low bar to ensure success this year as evidenced by provincial governments’ conservative targets for 2023. Investors currently expect a growth target in the 5-5.5% range, and a significantly higher target (e.g., 6%) announced over the weekend could be market-moving.
The GWR will mention some fiscal plans such as official on-budget deficit (GS expects 3.2% vs. 2.8% last year) and local government special bond (LGSB) quota (GS expects RMB 4tn vs. RMB 3.65tn last year). However, the more comprehensive fiscal budget proposal is likely released later during the Two Sessions. The projected tax revenue growth may inform us about the government’s expectation on nominal GDP growth, the planned transfer from central to local governments may hint at policymakers’ concern on local governments’ fiscal conditions and their determination in controlling local government implicit debt, and the government-managed fund revenue (mostly land sales revenue) may give us clues on policymakers’ view on the property sector momentum.
During the Two Sessions, changes to Party and state organizations and reshuffling of State Council and ministerial personnel, which were planned at the Second Plenum during February 26-28, will be revealed to the public and approved by the NPC. It has been reported in the media that the financial regulatory authority may be moved to a resurrected Central Financial Work Commission (which was first established in 1998 in the aftermath of the Asia Financial Crisis and abolished in 2003) led by Ding Xuexiang, a Politburo Standing Committee member. The current Financial Stability and Development Committee under the State Council and led by Liu He may cease to exist. And He Lifeng, a Politburo member, may replace Guo Shuqing, a Central Committee member, to become the party secretary of the PBOC. If true, these changes indicate an elevated importance of, and more party control over, the financial regulatory system.
Beyond these three key parameters, statements on sector-specific policies can be important to investors as well. For example, characterization of the property market, consumption boosting measures, and internet regulations are worth monitoring. Such discussions may be provided in the GWR, press conferences with ministers in economic and financial areas, and/or in official news reports by Xinhua, People’s Daily and CCTV. Additionally, statements in the GWR regarding Taiwan may also gather market attention
Where we are in the post-Covid recovery
To gauge policy stance to be unveiled at or after the Two Sessions, one must first assess where China is in its post-Covid economic recovery. Based on GS tracking of high-frequency data, mobility measures such as the 100-city traffic congestion index have mostly normalized (Exhibit 2). Channel checks and anecdotal evidence suggest that high-end consumer markets have been recovering quickly. In the property market, the 30-city daily property sales data showed notable improvements in recent days (Exhibit 3). Similarly, the NBS 70-city property prices and the Beke’s 50-city existing home prices showed increases in the latest readings. However, it should be noted that high-frequency data in the property sector tend to overweight large top-tier cities where fundamentals are more supportive of a faster recovery. Smaller lower-tier cities, by contrast, continue to struggle due to weak demographic and economic fundamentals as well as dampened price expectations. For many consumption categories, 2022 demand was dramatically below trend and there is still a long way to go for China’s post-Covid recovery, especially for services sectors, mass markets, migrant and young workers.
Four policy expectations
As mobility, consumption, and property have begun to show clear signs of recovering, the growth acceleration that the market expect this year is broadly on track. As a result, cyclical policy in aggregate should be less stimulative this year than last year. In fact, the PBOC has allowed interbank market rates (e.g., DR007) to increase to the level of policy rates (e.g., 7-day OMO), a sign of policy normalization after very loose liquidity conditions during and after the Shanghai lockdown last year (Exhibit 4).1 Despite higher headline official on-budget deficit and LGSB quota that will likely be released on the first day of the NPC, Goldman expects the augmented fiscal deficit, a more comprehensive gauge of fiscal stance, to narrow by 1.5% of GDP from 2022 to 2023.
But this is not to say that policy will tighten in the same abrupt and significant manner as it did in 2020H2. Precisely because the withdrawal of policy support and the imposition and tightening measures were too much too fast back then, policymakers will be more patient this time around, especially when the potential downside risk from weaker external demand remains considerable and confidence remains fragile. Even though the February PMIs were much stronger than expected and property prices in top-tier cities appear to be edging higher again, a meaningful withdrawal of policy support is unlikely until at least Q3 this year.
Policymakers have been reiterating the message of enhancing domestic demand and boosting private consumption since last December’s Central Economic Work Conference (CEWC). However, the likelihood of significant nationwide cash handouts remains very low. Between budget constraints and cultural preferences, the government will continue the past approach of using infrastructure investment to stimulate the economy when needed. Consumption-boosting measures will likely stay within the realm of tax subsidies for autos and home appliances, accelerated rental housing construction, and small-scale local consumption coupons.
Although the precise policy stance announced at or after the Two Sessions is difficult to predict, especially with the once-in-a-decade reshuffling at the State Council and in various ministries, there should effectively be a “policy put” for at least 5% growth this year. With GDP growth only reaching 3% last year and with 2023 marking the first year of the new premier’s 10-year term, the government’s tolerance for below 5% GDP growth this year will be low.
Two key risks, one external and one domestic
The most significant downside risk to China’s 2023 economic growth is exports. Chinese exports fell sharply in late 2022 (-9.9% yoy in December), in line with the experience of other export-oriented economies such as South Korea and Taiwan and suggesting external demand has indeed been softening. Recent media reports also highlighted empty containers at ports and dwindling overseas orders. Goldman’s baseline expectation is flat real goods exports this year as its global team projects no recession in the US or Europe over the next 12 months. However, if exports turn out to be a lot weaker than expected, policymakers may need to boost monetary/fiscal easing and infrastructure building again. Given the more limited fiscal space after last year’s efforts to stabilize the economy, additional infrastructure investment would likely be financed through policy banks and commercial banks instead of government debt.
Onshore conversations suggest business and consumer confidence remains the main risk to growth domestically. Without confidence, the post-Covid recovery may not be sustainable as private firms are reluctant to invest and households are reluctant to spend. The recent message from the Central Commission for Discipline Inspection against “financial elites” and “hedonism and extravagance” has raised concerns that anti-corruption campaign could intensify this year. Hence, communications from the top economic and financial policymakers in the new government after the Two Sessions will be particularly important to watch.
There are certainly other risks in the economy. US-China relations have weighed on investor sentiment after the balloon incident, US Secretary of the State Antony Blinken postponing his trip to China, and media reports of China considering supplying arms to Russia. We may see more negative headlines in the coming months. However, this is a structural issue and the impact on economic growth this year still looks limited thus far. Financial risks from small and rural banks and local government financing vehicles (LGFV) could re-emerge later this year if NPLs are recognized and interest rates rise after policy normalization. But such risks can be managed and the Zunyi LGFV bond restructuring in January was an example. Risks of policy overtightening also appear low due to the experience of 2020/2021, and as discussed earlier, policymakers will be more patient this year.
Overall, China’s post-Covid recovery has just started with some encouraging signs, setting the stage for Goldman’s forecast of 5.5% full-year GDP growth (and 6.5% yoy in Q4) which is above consensus (Bloomberg consensus 5.2%). The government is likely to remain patient in withdrawing support, and to stand by to ease in the event that recovery disappoints or exports fall short. After the strong February PMI print, the market will be focusing on hard data such as January/February trade (to be released on March 7) and retail sales (to be released on March 15). If these hard data surprise meaningfully to the upside, the risk-on market movements featuring stronger RMB and higher equity/rates/commodities will continue.