China’s Power Crunch Steals Macro Limelight

“Yet another growth shock.”

That’s how Goldman described China’s worsening energy crunch on Tuesday.

You could also call it the latest blow to macro sentiment at a time of gathering headwinds.

In a new note, Hui Shan cut the bank’s growth outlook for the world’s second largest economy to 0% for Q3. That’s a sequential projection. YoY, the Chinese economy likely expanded 4.8% this quarter, Goldman said. Their full-year projection is now 7.8%, down from 8.2% previously.

You can make this story as complicated or as simplistic as you like, but the bottom line is that between Beijing’s efforts to meet environment targets, pandemic effects and a coal supply shortage, there’s not enough power.

Factories are being compelled to curtail operations at a time when rampant supply chain disruptions are already upending the global economy. Mandates aimed at cutting electricity consumption will invariably weigh on growth in key provinces, and at the worst possible time.

Growth was already decelerating and between sub-50 prints on both the official and Caixin non-manufacturing PMIs and an extremely poor read on retail sales for August, it seems highly unlikely that the services sector is in a position to pick up the slack.

“It presumably was not the intention of policymakers to provoke a sharp tightening, at least when the [environmental] goals were initially formulated [but] the peculiar nature of the COVID shock has made the economy more energy-intensive, at least temporarily,” Goldman said, adding that “the boom in exports has boosted energy-intensive manufacturing industries [while] efforts to reduce coal-fired related emissions and a reduction in coal imports have affected supply levels at least on the margin, contributing to a sharp increase in prices.”

Apparently, the diplomatic spat with Australia is making the situation worse. “China stopped buying the highly energy-efficient Newcastle grade from Australia starting last year,” Bloomberg noted.

Beijing’s “zero tolerance” COVID policy already had macro watchers worried. Strict adherence to draconian containment measures led to two high-profile port disruptions over the spring and summer, testing the global shipping industry anew.

Ultimately, exports were undaunted but signs of “friction” are painfully easy to spot. Shipping rates have skyrocketed, for instance (figure below, from BofA).

This has some concerned ahead of the holiday shopping season in the West. The factory curbs are almost sure to make things worse.

Take Clark Feng, who spoke to Bloomberg Monday, for example. Feng “buys tents and furniture from Chinese manufacturers to sell overseas,” the linked article explained, before noting that “electricity curbs in the eastern province of Zhejiang, where the company is based, have dealt another blow to businesses [while] fabric makers in the province that are suffering production halts have started to hike prices and postpone taking new overseas orders.”

That short anecdote neatly encapsulates the multi-faceted problem as it’s manifesting “on the ground,” so to speak.

Nomura’s Ting Lu, who last month characterized China’s property crackdown as a kind of “Volcker moment,” now sees the economy shrinking on a QoQ basis. “With market attention laser focused on Evergrande and Beijing’s unprecedented curbs on the property sector, another major supply-side shock may have been underestimated or even missed,” he wrote, in a new piece which contained the following useful recap:

In September 2020, President Xi Jinping announced that China would reach peak CO2 emissions before 2030 and carbon neutrality by 2060. After that, the State Council and several ministries set ambitious 2021 targets for cutting energy intensity and energy consumption. Enforcement is key, and the real game changer came in mid-August, when the National Development and Reform Commission (NDRC), China’s state planner, announced that 20 mainland Chinese provinces failed to achieve their goals on cutting either energy consumption or energy intensity in H1 this year. These 20 provinces account for 70.2% of China’s GDP and 73.5% of the secondary sector. News flow seems to suggest that these regions need to remedy this shortcoming over the remainder of this year, and some major cities in the economic powerhouses of Jiangsu and Zhejiang provinces have already rolled out draconian measures to suspend the operation of many factories.

And, so, factories are closing down, either because local governments are ordering them to or else because they don’t have any power.

Nomura’s YoY Q3 and Q4 GDP forecasts are now 4.7% and 3.0%, respectively, down from 5.1% and 4.4%. The bank’s annual GDP growth projection for this year is 7.7%, a touch below Goldman’s.

As the figure (on the left, above) shows, Nomura sees GDP growth of -0.2% QoQ in Q3. “Even with these cuts, we see more downside risk to our forecasts,” the bank warned.

In addition to supply shocks associated with green measures, energy and soaring factory-gate inflation, Nomura reiterated (in the same report) that China also faces a trio of “major negative demand shocks.” These are familiar. One is new COVID waves, another is a potential property meltdown and a third is a prospective deceleration in export growth.

Needless to say, the situation is fluid. All of this comes amid Xi’s sweeping regulatory crackdown on everything from big-tech to ride-hailing to food delivery to actors’ pay.

Goldman called uncertainty around Q4 “very large.” “A lot of this comes down to the stance of both macro and regulatory policy,” the bank remarked, citing the possibility that Beijing could take measures “to stabilize housing sector activity and stretch out the deleveraging in the property sector.” It’s also possible, Goldman said, that Xi could order a “temporary relaxation of regulatory pressures to meet energy use targets.”

Who knows. What we do know is that this is yet another potentially gale-force macro headwind at a time when some developed market central banks, including the Fed, are keen to dial back stimulus.

On Tuesday, the PBoC’s Yi Gang said the Chinese economy is expected to maintain a potential growth rate of between 5% and 6%. He also said central banks should avoid asset purchases as much as possible. QE, he remarked, could damage market functioning.

For their part, Nomura cautioned that this is no small matter. “The power-supply shock in the world’s second-biggest economy and biggest manufacturer will ripple through and impact global markets,” the same cited report warned.

“I believe global markets will feel the pinch of a shortage of supply from textiles, toys to machine parts,” Ting Lu said. “The hottest topic about China will very soon shift from ‘Evergrande’ to ‘Power Crunch.'”