Analysis on the Economic Situation in 2022 from the Perspective...

Title: Analysis on the Economic Situation in 2022 from the Perspective of Cross-Cyclical Adjustment

Author: Zhong Wei, Wei Wei, Dai Kang

Zhong Wei: Welcome both of you to participate in this "round table" discussion. Since the beginning of 2021，China's economic growth has gradually come back to normal，but it is also facing many new uncertainties: the multi-points spread of COVID-19 has plagued the local economy; the high commodity prices have driven the producer price index (PPI) to always run at a high level; since the second half of the year，the economic growth and market expectations have tended to converge; some local risks have appeared in the real estate industry，etc. How do you see the economic growth in 2021?

Wei Wei: In 2021，the domestic macroeconomic performance can be summarized as "the second half of the recovery" with the characteristics of "quasi-stagflation". According to the apparent data，due to the base of "low before high" caused by the pandemic last year，almost all macro indicators this year show obvious characteristics of "high before low". Especially in the second half of the year，the decline of macro indicators is even more pronounced. However，in terms of the two-year compound growth rate，various indicators are still in a slow recovery from the impact of the pandemic，and the GDP compound growth rate is generally stable.

On the whole，the macro economy in 2021 presents the following characteristics. First，weak domestic demand. Judging from the two-year compound growth rate，neither the growth rate of fixed asset investment nor the growth rate of total retail sales of consumer goods has returned to the level before the pandemic. In addition，due to short-term impacts such as the multi-points spread of the pandemic，the disturbance of the summer flood，and risk prevention policies，the performance of investment and consumption is not satisfactory. Second，strong external demand. With different situations of controlling pandemic overseas，the obvious recovery of demand in developed economies and the slower recovery of production in emerging economies have made the advantage of China's exports last year continue into this year. Third，the high PPI. While the domestic economic momentum is gradually weakening，the commodity price continues to surge against the backdrop of the recovery of overseas demand and the domestic expectations of production restrictions and carbon neutrality policies，driving the PPI to a new high year-on-year. This makes the economy present a "quasi-stagflation" pattern.

Dai Kang: For the economic growth in 2021 as a whole，I see global growth momentum at the top，while the domestic growth momentum is of marginal weakening but still resilient.

The main reason why overseas growth momentum is at the top is because the current overseas economic recovery is highly correlated with vaccination rate，which has slowed in Europe and the United States. Empirical data shows that the correlation between overseas economic recovery and vaccination rate is as high as 0.67. The global multi-points spread of the pandemic in the second half of the year will also hamper the recovery of the global economy to some extent.

The domestic growth momentum is of marginal weakening but still resilient，which is mainly reflected in two aspects: on the one hand，the weakening momentum of overseas economic recovery in the second half of the year will reduce the overseas demand，thus slowing down the momentum of domestic economic growth; on the other hand，the increase in the expectations of markets for the "steady growth" policy will strengthen the expectation that the economy will remain "resilient" throughout the year. For instance，for consumption，the Ministry of Commerce issued the Notice of Further Fulfilling the Key Tasks of Promoting Consumption in the Current Commercial Sector on September 16，with the efforts to improve the domestic consumption; for public finance，the issuance of local special bonds has sped up since August，and the amount of issuance reached 879.7 billion yuan in August，creating a new high in this year. From September 1 to September 17，the issuance of local special bonds amounted at 612.8 billion yuan.

Zhong Wei: Investment，consumption and foreign trade are regarded as the three major driving forces of economic growth. The investment mainly consists of three parts: manufacturing investment，infrastructure investment and real estate investment. What are your opinions on the structural change of investment? Particularly，will infrastructure investment boom soon，and are there any unexpected risks in real estate investment? Meanwhile，recovery of life service industry remains unbalanced，and total retail sales of consumer goods has slowed down significantly since August. Is consumption able to maintain its position as a ballast stone of economic growth? And what are your predication on investment and consumption in 2022?

Wei Wei: Before the outbreak of COVID-19 pandemic，real estate investment was a strong component of fixed asset investment，with a growth rate of about 10%; while investment in infrastructure and manufacturing were relatively weak，growing at a low level between 2% and 3%. After the outbreak of the pandemic，real estate investment gained the fastest recovery in terms of the two-year compound growth rate as real estate sales improved under the loose monetary policy. During recent months，however，it has declined from the peak due to the increasingly tightened policy on real estate financing and centralized land supply，and is expected to maintain a slowly downward trend in the near future. Currently，the compound growth rate of infrastructure investment is still hovering at around 2% to 3%，mainly holden back by rising local debt risks and lack of infrastructure projects. In the following months，China will accelerate the issuance of special bonds and the construction of major projects. However，relevant funds may be available with time lag within this year，and the startup of construction work may be encumbered due to cold weather in the fourth quarter. Therefore，we expect to see an increase in infrastructure investment in the first quarter of 2022. Manufacturing investment was the hardest-hit area in the COVID-19 pandemic. Rising costs of upstream materials，recurrent pandemic and persistent weak domestic demand may weaken the investment willingness of manufacturing enterprises. On the whole，there is still room for improvement in manufacturing investment，but it is not possible to show very strong performance against the backdrop of a downward economic momentum.

The less-than-expected recovery of consumption growth rate is mainly caused by the short-term impacts and long-term willingness. In the short term，the repeated outbreak of COVID-19 pandemic and its influence to economic activities have far exceeded market expectations，and coupled with the flood season in August，consumption has suffered greatly. At the same time，the cyclical downward trend of the economy itself also leads to weak consumption. Real estate-related consumption (construction materials，furniture，home appliances，etc.) and upgradation consumption (automobiles，jewelry，cosmetics，communication equipment，entertainment，etc.) both show a downward trend. In the long term，on one hand，the twists and turns and long duration of COVID-19 pandemic will increase the precautionary saving and reduce the consumption capability of residents. On the other hand，the tightening of real estate policies will affect the continuous rising expectation of housing price，and the decline of wealth effect of residents will ultimately lower their consumption intention. The consumption behavior of residents may change in the long run due to these two reasons. Looking forward，the recovery of consumption still largely depends on the situation of pandemic.

Dai Kang: Three major structural changes in investment worth our attention. First，the “stabilizing growth” of infrastructure investment has gradually shifted from the "observation period" to "validation period". One example of this is the acceleration of project landing of local special debt. Second，the marginal contribution of manufacturing investment，especially high-end manufacturing investment related to the export chain，will gradually increase. At present，A-share is starting a new round of structural manufacturing capacity expansion，and we may clearly see this capacity expansion of "export chain" related high-end manufacturing either in the financial statements or the manufacturing investment data of enterprises. Third，the marginal contribution of real estate investment will gradually weaken.

Consumption will continue to face relatively large downturn pressure soon，but the policy implementation may ease the pressure. Rise in commodity price has restricted the downstream consumption potential to a certain extent. High commodity price has resulted in profit reallocation among the upstream，midstream and downstream，and the profit margins of the downstream consumer industries，especially the labor-intensive optional consumer industries，have been significantly squeezed，which will further limit the salary expectations of workers in these industries，and ultimately affect the macroeconomic data of total retail sales of consumer goods. In spite of all these facts，we can see that the regulatory departments are exerting more efforts to ease the potential impact of high commodity prices on consumption. For instance，the Notice of Further Fulfilling the Key Tasks of Promoting Consumption in the Current Commercial Sector，was issued by the Ministry of Commerce on September 16 this year，mainly to stabilize commodity consumption and major consumption and to promote the development of new types of consumption and consumption platforms.

Generally speaking，we will see A-share earnings entering a downturn cycle in 2022，and the momentum to drive steady growth of investment and consumption will be relatively strong. Infrastructure investment is expected to increase，driven by the policy of "forming the physical work". To view from the consumption end，unlike the “investment-oriented” fiscal policy after the 2008 financial crisis，the supervision authority adopted a "mixed" fiscal policy after the 2022 COVID-19 pandemic that took both investment and consumption into account. Thus，if facing high economic downturn pressure in 2022，we may also expect the introduction of consumption related policies，for instance，the issuance of consumption coupons，in addition to the stabilizing growth policy in infrastructure.

Zhong Wei: Since the outbreak of COVID-19，the trend of China's foreign trade has always been improving. Many scholars have also pointed out that the increase in China's foreign trade share in the global market is likely to stabilize，rather than plummeting. However，there are also worries. For example，the neighboring markets in Southeast Asia，the traditional markets in Europe and the United States，and the markets along "the Belt and Road" register similar growth rates. In addition，the performance of processing trade and bonded areas is not satisfactory while the general trade is booming. What are your predictions and expectations for China's foreign trade next year?

Wei Wei: In 2021，the exports remain strong，but structural changes have taken place: the export of medical-related commodities has plunged，and the export of other labor-intensive products，as well as electromechanical，high-tech and new-tech products，has performed well，conforming to the switch of overseas demand. On the one hand，with the widespread vaccination，the global pandemic has been contained to a certain extent，leading to a significant drop in the demand for medical-related products; on the other hand，the pandemic has been basically brought under control in advanced economies，but not in emerging economies，which makes it difficult for their production capacity to recover quickly. As a result，overseas demand is concentrated on China again，with the export demand for traditional advantageous commodities continuing to increase.

At present，the overseas economy is still in recovery after the pandemic，with the overseas demand still rising. Considering the relatively strong competitiveness of domestic export products，the export growth rate can maintain a high level in the short term. In the future，as the pandemic is brought under control，the productivity of emerging economies is restored，and the capacity of the global shipping industry is recovered，China's current high export growth rate will tend to decline. The duration of China's export growth depends mainly on the control of the pandemic and the process of the recovery of world economy.

In the medium and long term，China's export competitiveness is expected to continue to improve. First，China's industrial chain has shown outstanding stability during the outbreak，which will affect the production layout of multinational companies. The pandemic has made multinational companies tend to shorten the industrial chain and produce their products near the consumer market，which may help gradually form three industrial chain clusters in East Asia，Europe，and North America，and China will figure prominently in the regional industrial chain of East Asia. Second，with the prolonged and complicated competition and game between China and the United States，China will integrate into the global market with a more active attitude and seek in-depth cooperation with other economies，evidenced by China’s application to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). Deepening cooperation with other economies will help promote the benign interaction between trade，capital，technology and market，and enhance China’s export competitiveness.

Dai Kang: Generally speaking，China's foreign trade will enjoy a favorable environment next year. On the one hand，the pandemic has profoundly changed the global supply chain，further strengthening China's position in it. The world's raw materials flow to China，and manufactured goods are exported from China to the world. From the perspective of manufactured goods，the European countries and the United States quickly recover this year，but the Southeast Asia countries are largely handicapped. Since the European countries and the United States mainly focus on the manufacturing of middle and upper end industrial products，while the Southeast Asia countries on low end industrial products，many of the industrial intermediate products are heavily replying on China's supply chain. At the same time，the Southeast Asia countries are generally badly hit by the third wave of the global pandemic，which will also bring global orders back to China. Nationally，from January to May，orders returning to China amount at US$80 billion. On the other hand，the foreign trade policy environment will continue to be optimized. In 2020，the ultra-conventional measures to "maintain the stability" of foreign trade，especially the financial support policies，have played a key role in the "cost reduction and risk prevention" of foreign trade companies. This year，the State Council executive meetings have also focused on the foreign trade industry，especially on accelerating the development of new formats and models of foreign trade，which has further accelerated the development of cross-border e-commerce and overseas warehousing. We have observed the rapid growth of the cross-border e-commerce and overseas warehousing in the past two years，and the policy will continue to further improve the foreign trade environment next year.

Zhong Wei: Taking the above factors into consideration，what are your forecasts and expectations of the major macroeconomic indicators including the economic growth rate in 2022? The year 2022 will witness the Beijing Winter Olympics at the beginning of the year and the government succession，which will bring considerable challenges to both controlling the pandemic and stabilizing the growth. From the perspective of cross-cyclical adjustment，what are your expectations and suggestions for the macro-control at the end of this year and next year?

Wei Wei: In 2022，after getting rid of the influence of the base factor，the macroeconomic growth will most likely return to the original track，with the GDP growth rate back to the slow downward trend. It is expected that China's economic growth rate will basically return to the original range of 5% to 6%，and the GDP growth rate will be around 5.8% in 2022.

In terms of macro-control policies，we need to understand and distinguish the difference and connection between cross-cyclical adjustment and counter-cyclical adjustment in the first place. Counter-cyclical adjustment mainly refers to the use of monetary and fiscal policies to hedge against short-term economic fluctuations; while on that basis cross-cyclical adjustment takes more into consideration the medium and long-term economic issues，including the growth and the structure. Therefore，from the perspective of policy tools，cross-cyclical policies include the role of national macro-control in more areas in addition to monetary and fiscal policies，such as industrial policies，regulatory policies，environmental policies，and regional policies. From the perspective of policy duration，cross-cyclical policies often cover several economic cycles in the future rather than a short-term economic cycle. Therefore，facing the downward pressure of the economy amid the pandemic in 2020，more counter-cyclical adjustments are considered in policy-making to address the downward pressure of the economy，and stabilizing the growth becomes the focus of macro-control policies; while policies promoting adjustments of economic structure launched in the first half of this year，such as carbon neutrality，antitrust in Internet，normalizing after-school education，and policies preventing risks，such as strict risk control of local bonds and tightening up of real estate financing，both belong to cross-cyclical adjustments.

At present，the economy in the second half of 2021 has been under relatively obvious downward pressure，incurring the rising of local credit risks. Therefore，the current macro environment imposes higher requirements for coordinating the future counter-cyclical adjustment and cross-cyclical adjustment policies，and the focus，pace，and strength of these two policies will be tested. Short-term policies may need to shift from cross-cyclical adjustment to counter-cyclical adjustment，from risk prevention to growth stabilization; at the same time，it is also needed to flexibly adjust the monetary policy，strengthen the fiscal policy，further consolidating the foundation for domestic economic recovery and ensuring stable economic performance.

Dai Kang: I think there will be a certain downward pressure on macroeconomic indicators at the end of this year and next year，and the "stabilizing growth" policy will gradually enter the "confirmation period". However，the effects of “stabilizing growth” policies need to be further observed. For instance，there is sign of gradual growing up of special bonds，however the implementation of infrastructure projects and the pulling effect of these infrastructure projects can be evaluated until mid-November. Thus，we should not predict the major macroeconomic indicators of this year prematurely，unless the infrastructure projects for stabilizing growth and its effects are unequivocal.

As for the macro-control，it is expected that under the policy guidance of "forming physical work"，the macro policies in the second half of this year and next year may continue the main line of "stabilizing growth". It is not ruled out that the infrastructure chain will further strengthen or the stimulus policies for the consumer industry (such as the popularization of consumer vouchers) will be further increased. In addition，the macro-control policies since the second half of 2020 have remained stable，and sufficient room for policy operations has been reserved to some extent for "stabilizing growth" in 2022. In case there is greater downward pressure on the economy in 2022，and a tightening cycle of the world economy，the regulatory authorities will have adequate countermeasures to achieve "stabilizing growth".

Zhong Wei: Despite the Sino-US trade friction and the impact of the pandemic，the performance of China's A-share market has been remarkable since the second half of 2018. In the third quarter，when the social financing and credit growth did not significantly increase，the stock market trading volume remained above one trillion yuan. Considering the macroeconomic pattern in 2022 and possible cross-cyclical policies，what predictions and suggestions do you have for the stock market next year?

Wei Wei: We can judge the performance of the A-share market next year from the following aspects. From the perspective of fundamentals，the macroeconomic growth rate in 2022 will tend to decline. At the same time，prices，especially PPI，will peak and fall year-on-year，and corporate profit growth will also tend to drop. From the perspective of liquidity，with the downward pressure on the economy further confirmed，the policy focus will shift from cross-cyclical adjustment to counter-cyclical adjustment. Risk-free interest rates are likely to return to a downward trend next year，which is beneficial to the uplift of stock market valuations. From the perspective of policies，with the advancement of reforms and the continuous strengthening of supervision，the capital market is becoming healthier，more orderly，and more standardized; at the same time，China vigorously supports scientific and technological innovation，and the early stage development of scientific and technological innovation enterprises in emerging industries is more in need of support from the equity market.

Overall，the A-share market will fluctuate upward in 2022. Growth stocks with more room for valuation uplift and greater flexibility will perform better than value and cyclical stocks. In terms of industry structure，the following two lines of logic may continue to affect industry investment opportunities in the market: first，against the background of carbon neutrality，industries such as new energy，power infrastructure，new energy vehicles，and environmental protection may continue to benefit; second，in the context of intensified external competition and dual economic circulation，scientific and technological innovation will still be strongly supported by national policies.

Dai Kang: I believe in 2022，A shares will usher in a new round of downward profitability cycle. The pro-cyclical midstream manufacturing and gradual deployment of optional consumption capacity will worsen the supply and demand structure of the industry to a certain extent; the expected marginal tightening of the global liquidity will also restrain domestic liquidity. Therefore，it is not very likely that the A-share market will see a large-scale rise next year.

From the perspective of structure，the overall market style next year will favor consumer and technology stocks，and the technology industry may perform even better. In terms of general rules，both consumer and technology stocks can obtain substantial relative returns during an earnings downcycle. The earnings of A-share market in the long run present characteristics of cyclical fluctuations，among which，from 2012 to 2013，it is a round of upstream of earnings，from 2014 to 2015，it is a round of downstream of earnings，from 2016 to 2017，it is a round of upstream of earnings，from 2018 to 2019，it is a round of downstream of earnings. According to the data from 2020 to 2021，it is should be a round of upstream of earnings，thus it is most likely that A-share will face a new round of downstream in 2022. As can be seen from the last two rounds of downstream of earnings，the first round from 2014 to 2015 could be mainly attributed to the technology stocks influenced by lack of liquidity，and the second round from 2018 to 2019 could be mainly attributed to consumer stocks influenced by the increase of environmental uncertainties. It is expected that the domestic liquidity environment will remain relatively loose in 2022. The environmental "uncertainties" brought about by the pandemic will gradually decrease，and the "stabilizing growth" policy will also reduce the "uncertainties" of economic growth expectations to a certain extent. Therefore，technology stocks will continue to enjoy the advantages of relatively loose liquidity and low discount rate，but the determination premium of consumer stocks will weaken marginally. It is worth mentioning that the technology stocks in 2022 will benefit from the rise of risk preferences of 5G cycle，with the 5G new infrastructure launched gradually and Huawei’s starting up to build industrial chain of 5G Harmony OS.

Zhong Wei: Thank you both for participating. You have pointed out that the variable of real estate investment and the role of infrastructure investment in cross-cyclical growth stabilizing should be focused on in the investment field. Meanwhile，you are concerned about the slowdown of consumption growth，especially the recovery of life service consumption. Fortunately，the foreign trade still has considerable resilience. It seems that the economic growth rate may fall in the second half of 2021，and it may be slightly less than 6% in 2022. The cross-cyclical policies are expected be more active，flexible and effective.