What’s in store for China’s economy in 2021?

Wenli Zheng February 02, 2021 06:00

Thanks to its rapid control of the coronavirus, China was the only major economy to post positive economic growth in 2020, expanding 2.3% for the year, and in fact grew more strongly in the fourth quarter of 2020 at 6.5% than in the same period in 2019 at 6%. As we start 2021, momentum continues to build, and the signs are that China has done enough to successfully reflate its own economy.

This positive environment has led to dampened expectations of fresh stimulus, but there is no sign that the government will tighten policy prematurely. Rather, it appears to be taking a “wait and see” approach that could prevail for the next couple of quarters. On the monetary policy front, the People’s Bank of China (PBoC)’s broadly neutral policy sought to keep some ammunition in reserve, which has so far not been needed.

Expect 2021 to see a greater emphasis on President Xi Jinping’s “dual circulation” theory and sustaining higher quality growth, with a focus on internal drivers. Part of this implies the need for greater reliance on homegrown technology, which may lead to greater spending on research and development within capex budgets in the coming years. In the technology field, it is expected that China would prefer to cooperate than to engage in geopolitical strategic rivalry and may try harder in the future to achieve this.

Looking longer-term, President Xi is seeking to raise China’s per capita GDP to the level of “moderately developed countries”. This will require GDP growth to average around 4.8%, doubling the size of the economy – no easy task given China’s well-known medium-term structural problems of an aging population, rising debt burden, and lower potential growth as resources shift into lower-productivity services. The 2035 target is not out of the question, however, as economists expect China’s trend or potential growth to slow gradually from its current rate of 6%–7%, with a sharp collapse highly unlikely.

Despite the large positive growth divergence in China’s favor, the external balance has remained in surplus, supporting the renminbi, meaning that China has been able to increase its global export share during the pandemic. In a quantitative easing (QE) world of zero yields, China’s bond markets continue to attract strong inflows from fixed income investors. Bond yields may be close to peaking and index inclusion should draw more foreign assets into Chinese government bonds, providing further support for the renminbi. We believe favorable conditions for sovereign bonds and the renminbi should continue in 2021, providing a supportive backdrop for equity markets.

With incomes growing faster than spending in 2020, households have increased savings, some of which may also flow into equities. The positive fundamental outlook for Chinese equities in 2021 is even more attractive in relative terms given the still uncertain outlook for many other economies, both developed and emerging.

Increased household savings also means the consumer will likely play a bigger role in driving China’s economic growth in 2021. The prospects for consumer demand in 2021 look good, with auto sales well above 2019 levels and improving consumer confidence and pent-up demand across sectors.

One of the big shocks for investors in 2020 was the postponement of Ant Group’s initial public offering (IPO) in November, but this will unlikely impact the strong attractions that leading Chinese tech and new economy companies hold for global investors in 2021. The delay, in fact, will be a small price to pay if it means a better-regulated fintech industry. Until now, the regulators had adopted a liberal approach to fintech and are eager to avoid the mistakes when domestic investors lost over USD 100 billion as many unregulated peer-to-peer (P2P) lending platforms collapsed. Given the importance of commercial banks to China’s financial and economic system, a degree of caution on the part of the regulators at this point may be in investors’ best interests.

2021 will also see renewed focus on business relations, instead of government relations. The consensus within China is that although the U.S. and China are expected to remain strategic competitors, more communication and dialogue between them can better manage the risks, while allowing economic relationships to normalize. The phase one trade deal reached in February is expected to survive in modified form. Over time, it may progress to phase two issues such as intellectual property copyright and technology transfer. A cooling off in government rhetoric may encourage business leaders in China and the U.S. to quietly resume normal operations.

Pulling the above together, the outlook for the fundamentals for Chinese equities in 2021 looks positive for three key reasons: first, the economic recovery is expected to continue, with consumption the main driver; second, vaccine approval and distribution should allow China to reopen its borders to the rest of the world at some point next year; and third, global investors are structurally underweight Chinese equities.

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Wenli Zheng

Portfolio Manager of T. Rowe Price’s China Evolution Equity Strategy