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The Limits and Lessons of China's Recovery

With Robin Xing and Andrew Sheets

What China’s rebound from COVID-19 can—and can’t—tell us about the path, speed and pitfalls of economic reopening for other countries. Chief China Economist Robin Xing shares lessons learned so far and how the country has had to modify its crisis playbook.

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Current Episode Transcript

Robin Xing: Welcome to Thoughts on the Market. I'm Robin Xing, Chief China economist for Morgan Stanley.

Andrew Sheets: And I'm Andrew Sheets, chief cross asset strategist for Morgan Stanley. On this special edition of Thoughts in the Market, we'll be discussing the outlook for China's economy and the impact on the broader world. It's Thursday, May 14th at 1:00 p.m. in London,.

Xing: It's 8:00 p.m. in Hong Kong.

Sheets: Robyn, where I want to start was that China was the first country impacted by the coronavirus. And it's also been the first country where we can really observe the economic recovery. And so where I think we should start is, how do you think that recovery at the moment is going?

Xing: What China did is a the three-stage virus containment and economy reopening approach. The first stage is hard lockdown, lasted for about a month since late January. It's a hard lockdown in the sense that everyone stayed at home, non-essential services were closed. Once the virus went to a sustainable downward trajectory, they entered the second stage, replaced the lockdown with social distancing in March. So quarantine measures were gradually relaxed to give way to fix the production resumption in the industrial sector. For example, making cars and making smartphones. All these supply chain have been fully resumed production during this stage. And when you return to workplace, you need coffee. So coffee shops gradually reopened its doors about one month since the initial lockdown. Yet strict social distancing guidelines remained in place so that most service centers and the leisure places remained suspended. So there is no socializing or gathering. So I would call this stage, "returned to work, not hanging out.".

Now, going into April and May, they are currently in the final stage of soft social distancing, which meaning features carefully reopening of the serv ice economy and the domestic travel. Including, for example, reopening of the theme parks. Kids are back to school. So the sequence of the three stages is largely ranked by the tendency of drawing people together, which means that the manufacturing sector will recover first. And given manufacturing is a big part of Chinese economy. We think China's economy could bounce back relatively more easily than most developed economies.

Sheets: Yeah, that's very interesting, Robin. Because as, you know, we've been looking at when we do look back at the 1918 pandemic, you really do see a pretty striking pattern where, you know, regions that lock down most severely in 1918 in the US actually did see, as you mentioned, you know, some of the largest ensuing rebounds in industrial production. But I'd like to draw a little bit more into something you mentioned about the difference between what's going on in the manufacturing side of the economy and what's going on in the services side of the economy. And maybe if you could talk a little bit more about, you know, what is some of the data that you're following, or what do you think might be some of the data that you think might not be getting as much attention from the average investor, but that you think is pretty interesting for how you think about those two segments of the economy?

Xing: What data is so important for watching the Chinese economy, particularly for the high frequency data. The high frequency data, which is daily or weekly data rather than the monthly or quarterly GDP we got, have greater value with a large inflection and this Covid-19 brought about the sharpest inflection possible in modern history. Against this backdrop, Morgan Stanley research franchise has delivered a comprehensive set of high frequency data that help investors to measure where the economy stands at and where it is going.

So what do these data tell us? In a nutshell, industrial production and infrastructure construction demand has fully recovered, but service demand is lagging. In particular, aside from the release of some pent up demand for big ticket items like cars, smartphones, the travel or leisure part of the economy has been lagging. And we think it won't fully normalize until maybe fourth quarter of this year because there is still a public health concern about a second wave of infection and there is still soft social distancing guidelines over there. They are reopening the service economy with some soft social distancing guidelines and the public health measures. This stage could stay with them for a while depending on the virus situation.

Sheets: So, Robin, when we think about what can governments do to address this economic challenge, a unique issue that China is dealing with is that it has been previously trying very hard to clean up some of the structural imbalances in the country. So, you know, how has China tried to deal with that? How do you stimulate the economy while not encouraging and reopening some of those imbalances that you've been trying really hard to correct?

Xing: That's a great question. Let me first point out that the nature of this shock from COVID-19 on Chinese economy is very different. It's hitting the SME, which is small and medium sized firms and households more than anything else. So China will not just resort to the old playbook of boosting public investment. Instead, they have adopted a three stage policy support approach, starting with stage one, that's the economic relief measures, targeting the troubled sectors and the small firms with relending and temporary tax cuts to these corporate cashflow shortfalls. Then they enter the second phase, started in March and April with some targeted infrastructure CapEx, but largely focusing on certain manufacturing sectors, which stood ready to provide key materials for the recovery of the economy. Finally, we think going in to the May 22nd National People's Congress, they will start providing Stage 3. That's that direct support for SME and household in the form of tax rebates, consumer coupons, some cash payments for as much as two hundred billion dollars. So this is the three stage playbook of the policy support in this COVID-19 situation, which is quite different from their traditional playbook of boosting public CapEx.

So with what we learned from China on the sequence of economic recovery post-Covid and also in view of recent U.S. China rhetoric on the Covid, what's your view on the global markets?

Sheets: So I think there are a couple of interesting lessons. I do think it shows that there were potentially some big advantages from shutting down more aggressively earlier. Now, I think for many countries, the time for that is passed. But I do think that that will mean that we are going to see just a very different case numbers by country based on how that response was. The other I think interesting thing about China's experience is that split between manufacturing and services, that if we look at economies like the US and Europe, which are far, far more services heavy. And as you mentioned, you know, that's the part that that even with kind of massive support, China's struggled the most to normalize. That also suggests a slower pace of recovery in the U.S. and in Europe relative to what you're gonna be forecasting in China.

Xing: Now Andrew. I know you asked me, China's sequence of the economic recovery may shed some light to what we may expect from other economies. However, one thing China is struggling with is providing direct support full to small business and households. So what China can learn from other countries stimulus playbook in this Covid-19 Recession?

Sheets: I think this is interesting just because we are seeing kind of in real time a lot of different countries taking a lot of different approaches. But I would say, you know, one element that has so far appeared very successful is finding ways to assist companies with their payroll, because if you think about the expenses for any small and medium sized business, payroll is the majority of their expense. If the government can find ways to support that, then I think you can avoid a lot of inefficiency and a lot of fear where people get fired, they potentially lose benefits, they will save more, they will consume less because they're worried about their job. And so finding ways to kind of plug the hole, as it were, on the payroll side you can address a lot of different challenges almost with one action. And so I think it's interesting. We've seen, for example, Denmark be very successful in having multiple segments of the economy work together from labor to businesses to the government. And ultimately, you know, they are so far seeing a far, far lower labor market impact, unemployment impact, than we're seeing in the U.S. or the U.K. or China.

Xing: Thank you. That's very important takeaways. Hopefully we can see that from upcoming National People's Congress on the Chinese stimulus measures.

Sheets: Robin, it's been great chatting with you.

Xing: Great speaking with you, Andrew.

Sheets: Thanks for listening. If you enjoy thoughts on the market, please take a moment to rate and review us on the Apple podcast app. It helps more people find the show.