EXECUTIVE SUMMARY
- We expect a limited negative impact of the Russia-Ukraine conflict on China’s economic growth, energy costs, and onshore credit conditions. We remain constructive on the RMB and the credit fundamentals of Chinese metals producers. However, China assets including Chinese corporate $ bonds could sell off alongside global risk assets if the situation escalates. China’s stance and the evolving US-China relationship could also complicate the situation and result in investors reducing China exposures.
- Trade is the most prominent economic linkage between Russian and China, but we expect the Russia-Ukraine conflict to have a limited negative impact on China’s growth. This is because Russia accounts for a relatively small share of China’s exports and imports. In our view, China would likely absorb more Russia energy exports and Russia could import more China manufactured goods.
- Despite military action commencing last week, the RMB strengthened versus the USD including on a trade-weighted basis. We expect the RMB’s rally could extend in the near-term thanks to China’s strong FX inflows, a resilient current account surplus, the absence of services and tourism related outflows, and a continued global reserve allocation to the RMB, in particular by the Russian central bank.
- We do not expect a significant tightening of China’s onshore credit conditions. This is because of the accommodative monetary and fiscal stance adopted by the Chinese policymakers since 4Q21, the PBOC’s generous open-market operations to ensure interbank liquidity, and the selective property easing measures pushed forward by local governments. In addition, China’s onshore corporate bond default rate was lower in 2021 than in 2020, with zero defaults from state-owned-enterprises (SOEs).
- The Russia-Ukraine conflict has sent global commodity prices higher due to potential disruptions of energy, grain and metal supplies, but we expect limited upward pressure on China’s CPI inflation, and there in fact could be marginal benefits for Chinese oil importers and Chinese aluminum producers. It is worth noting that grain has a small weight in China’s CPI index and China has accumulated strategic grain reserves. The Chinese gas distributors have limited exposure to spot LNG prices as they mainly source their gas supplies from Chinese national oil companies under long-term contracts with regulated prices. China is likely to increase Russian crude oil imports, which are currently trading at a discount to Brent. Should European aluminum smelters cut production on the back of higher gas and production costs, it could benefit aluminum prices and Chinese aluminum producers. In addition, we expect Chinese authorities to continue to aggressively intervene in the onshore commodities market to control price inflation.
- We don’t think the Russia-Ukraine tension will have a material impact on Chinese banks’ operations. This is because of their limited lending exposure to Russia and the potential increased use of China’s own cross-border interbank payment system (CIPS) as an alternative settlement system.
