Employees working on the production line of carbon fiber badminton rackets at a factory in Sihong County, in China’s Jiangsu province. China reported Saturday that factory activity in April contracted at a steeper pace as Covid-19 lockdowns halted industrial production and disrupted supply chains.
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Morgan Stanley raised its outlook for China’s economy in 2023, predicting a rebound in activity will come earlier and be sharper than expected.
The firm raised its forecasts for the country’s gross domestic product in 2023 to 5.4% from its previous outlook of 5%, according to a research note led by the firm’s chief Asia economist Chetan Ahya.
“We had previously expected a rebound in activity to materialize from late 2Q23. Now we are projecting mobility to improve from early March,” the note said, adding that the firm expects to see a “faster and sharper rise in mobility” to be reflected in the economy starting in the second quarter.
The outlook upgrade comes after the firm raised its recommendation rating for Chinese equities to overweight from equal-weight earlier this month on reopening optimism, marking the end of a stance that it held for nearly two years.
China’s government is also shifting to prioritizing economic growth, another pillar behind Morgan Stanley’s revised forecast for the country’s economic outlook.
“From our perspective, policymakers are taking concerted action to lift growth across all fronts,” the note said. “This is the first time since 2019 where domestic macro policies and Covid management are aligned in supporting a growth recovery, rather than acting as countervailing forces.”
Reuters separately reported that the nation is working on a stimulus package worth more than $143 billion to support its semiconductor industry, which would be one of its biggest-ever fiscal incentive package.
Morgan Stanley also sees China’s foreign exchange rates as underpriced.
“In FX, we don’t believe that the market is pricing in the reopening trade fully yet,” the note said, adding that forex traders have historically converted their holding of the U.S. dollar into Chinese yuan while the onshore currency was stronger.
“Given the recent appreciation of CNY, they now have more incentive to convert, pushing CNY stronger, especially before the Chinese New Year when they need to pay wages and bonuses,” the economists said in the note.
The onshore Chinese yuan stood at 6.9590 against the U.S. dollar on Wednesday morning – below the key 7.0 level against the greenback, which Morgan Stanley said makes it more attractive for exporters to buy more Chinese yuan with U.S. dollars.
“This is because the economic weakness will be reflected in fewer imports, supporting CNY,” the note said.
One of the risks that Morgan Stanley acknowledged is a potential withdrawal of policy support.
During China’s reopening process, analysts expect a surge in Covid infections. A rapid increase in hospitalizations and strain on the public health care system could possibly lead to officials in China rethinking their policy stance.
“An earlier-than-expected withdrawal of policy support – such as a sharp pullback in infrastructure spending, tightening of monetary policy, or a tightening of regulatory policies – could dampen animal spirits and weaken growth,” it said.
The report said further easing of restrictions will likely lead to a significant rise in Covid cases, though the firm predicted the impact of the surge will be short-lived.
Another area of uncertainty for Morgan Stanley’s growth outlook is geopolitics.
“The reappearance of geopolitical tension much earlier could also trigger a spike in China’s equity risk premium,” the note said.