March twenty-fourth, two thousand twenty-six
《After the Oil Shock: China’s Growth Story》
《After the Oil Shock: China’s Growth Story》
By Ariston
More accurately, China has not been and will not be excessively directly affected by this potential shock, but the details of its recovery and economic growth framework are changing.China is, of course, an energy importer and will, of course, be weighed down by higher oil prices. But what it faces is not simply a problem of more expensive oil, but a set of interconnected changes:
Figure: The oil shock is not a one-dimensional story in China
I. Why China cannot be lumped together with Europe, the United States, and the rest of Asia
China’s direct aggregate exposure to an energy shock in the Middle East is not as large as a superficial reading might suggest. In terms of its energy mix, energy from the Gulf Cooperation Council accounts for about 6% of China’s total energy consumption. Looking only at oil, flows related to the Strait of Hormuz correspond to about thirty percent of China’s total oil supply, but when set against the overall energy mix, their impact on total energy consumption falls to about 5%. Direct exposure to natural gas is even lower, at less than 1%. In addition, coal still accounts for nearly 60% of China’s primary energy, and is basically supplied domestically.
Relying on the single label of “high import dependence” can easily lead to an exaggerated account of China’s true vulnerabilities.
That is also why Chinese assets have reacted noticeably more moderately in recent times than those of India, Japan, and South Korea.
In fact, from the escalation of the conflict at the end of 2 to mid-3, volatility in China’s stock market, exchange rate, and 10-year government bond yields has been relatively contained. At least through last week, data on oil tanker arrivals at China’s major ports showed no clear disruption. Over the past six months, China’s implied crude oil inventories have also accumulated much faster than usual. Combined with administrative controls on refined product prices and a cap of 130 dollars, China’s market has a much longer buffer than those of other economies around the world.
As long as the shock does not drag on globally for too long, the Chinese economy will continue to be a relative outperformer over the foreseeable future.
Figure: China has the largest absolute volume of crude oil imports through the Strait of Hormuz, but its exposure is modest when measured against total energy consumption, and asset prices have reacted more moderately than in most Asian economies
II. Nominal variables, not aggregate demand itself
On closer examination, the most direct impact of this shock on China may be less about CPI at the end of the chain and more about the premature end of more than three years of PPI-driven deflation. As of this week, Citi has raised its forecast for China’s 26-year PPI from -0.4% to 1.0%, and expects the month-on-month reading for 3 to reach 0.8%, with the year-on-year figure turning positive after 41 months in negative territory. Goldman Sachs has also gradually raised its full-year CPI and PPI forecasts to 1.0%. The two firms use different model coefficients, but their core conclusion is the same: what China will see first is a change in nominal variables such as PPI and the GDP deflator, rather than inflation on the household side.(Citi estimates that an oil price increase of 10% corresponds to an increase of about 1.15 percentage points in PPI and 0.23 percentage points in CPI. Goldman Sachs is somewhat more conservative, estimating an increase of closer to PPI by 0.5 percentage points and an increase in CPI of 0.1 percentage points.)
This is not entirely bad news for China.
With PPI negative for 41 consecutive months and the GDP deflator contracting for 11 consecutive quarters, corporate profits, fiscal revenue, and micro-level expectations were already severely depressed. If oil prices now push these nominal indicators back into positive territory, that could actually ease some deflationary pressure in the short term, at least helping price expectations break free from the momentum of a continual decline and a vicious cycle.
But it is essential to distinguish nominal recovery from a revival in demand.It is more like a cost-driven price recovery: it can improve some accounting measures, but is not yet enough to show that household consumption, private investment, or service-sector prices have returned to a broad-based recovery:
Figure: The transmission of this oil shock to China is clearly more tilted toward PPI than CPI; the deflator is turning positive faster than inflation on the household side
III. Broad Reflation and Upstream Reflation
Often, when the market sees PPI turn positive, it naturally starts thinking in terms of broad-based reflation. But the PPI recovery driven by oil is concentrated, to the extent of about 80%, in upstream industrial sectors such as energy, metals, chemicals, and building materials.In other words, movements in certain specific sectors do not naturally mean that price pressures will spread widely down the industrial chain into midstream and downstream sectors.
More importantly, the pass-through from PPI to core CPI remains weak. Generally speaking, an increase of PPI in 1% corresponds to only about 5 basis points of change in core CPI; the impact of a supply-driven oil-price shock in 10% on core CPI is also just a few basis points, and its persistence is limited. In this situation, the duration of the shock is especially important: if it drags on, it can lead to sustained downstream margin compression, slower global demand, and raw-material shortages in Asia’s industrial chains. That is to say, China may get a little short-term support from the nominal recovery, but mistaking this for broad-based reflation could easily lead to overestimating the capacity of downstream sectors and consumer-facing industries to absorb the impact.
Chart: The improvement in PPI driven by oil is concentrated in upstream industrial sectors, with very limited spillover to core inflation and service prices
IV. China’s fundamentals are not weak at present, but it is still far from being able to ignore external shocks
Looking only at the data from the past two months, China’s fundamentals are actually solid in the short term, and could even be described as very strong.1-2 monthly industrial production, retail sales, and fixed-asset investment all came in above expectations, and the expanded fiscal deficit is also widening. However, the composition of these data remains typical: industrial production and service output are relatively strong, while retail sales and investment are still weak, The familiar problem of “strong production, weak demand” has not gone away; it has simply been masked for now by stronger external demand, fiscal support, and a post-holiday recovery.
...
Copper inventory data are also quite interesting...
According to JPM’s high-frequency tracking, in the week ending 3 month 20 day, visible copper inventories in China fell by 2.5 ten thousand tonnes. This drawdown came noticeably earlier than in previous years, and total inventories also fell to 47.3 ten thousand tonnes, gradually approaching the historical average.This shows that demand in the real economy is not entirely absent: at least some industrial chains are seeing improvements in operating rates and restocking, and copper demand provides a meaningful counterpoint to macroeconomic headwinds. But the tracking also cautions that the decline in copper prices since the conflict began still does not come close to fully pricing in macro risks, and technical support remains at a lower level.
Chart: The early drawdown in copper inventories indicates that industrial demand is not weak, but this is more of a counterweight to macroeconomic headwinds
V. The policy trajectory may change accordingly
If nominal variables recover first and growth does not immediately lose momentum, the first policy response will certainly not be to step up stimulus. PPI returning to positive territory would reduce the near-term urgency of using fiscal policy as a backstop again, and could also push expected rate cuts further out, at the latest to the second half of 26.
The logic is not complicated.
Over the past two decades, whenever China’s PPI has been in a pronounced upswing, policymakers have rarely delivered powerful stimulus at the same time. Once oil prices provide some support to upstream prices, corporate profits, and fiscal revenue in nominal terms, the urgency of easing declines.
The exchange rate is the other side of the same coin...
We set out the logic for stabilizing the renminbi without allowing it to move in one direction in our Wrap three weeks ago...
For those who have not read the views on USDCNH in this edition of “WEEKLY WRAP 260301,” be sure to go back and read them. We remain positive on renminbi appreciation, but for those expecting the same pace of appreciation as over nearly the past year to continue, the outlook here may be less favorable.In fact, the timing of our call a few weeks ago effectively marked a turning low (the red circle indicated by the arrow in the chart below):
Chart: USDCNH (daily chart, as of 260322)
Over the past week, CNH has mostly traded in the 6.87 to 6.91 range, and the daily fixing has also been notably stable. The CFETS index has been around 100.2 to 100.9, with 101 seen as resistance. More interestingly, exporters’ willingness to convert foreign currency into renminbi continued to increase in 1-2, and net foreign-exchange inflows in 2 remained at 440 hundred million dollars, while the monthly conversion rate among exporters was about 66%,This shows that the renminbi is not lacking fundamental support.
The only issue is that when oil prices, the dollar, and external uncertainty are all elevated, policymakers are certainly not seeking a trend appreciation, but rather a manageable, low-volatility exchange-rate environment. So the process ahead will still involve a stable fixing and two-way fluctuations.
Chart: For the renminbi, stability matters more than appreciation right now; the fixing, countercyclical factor, and volatility management are once again taking center stage
Six. Short-term risks lie in external demand; long-term opportunities do too
The impact of the shock on China’s external demand may be opposite in the short and medium term.In the short term, the most vulnerable economies are those with little inventory, limited fiscal space, and high dependence on imported energy. See 《260322 WEEKLY WRAP》 and Notes260317《Oil Prices Are Just the Opening Act; the Real Repricing Will Show Up in Growth, Exchange Rates, and Industrial Supply Chains》》A significant marginal contribution to China’s export growth in recent years has come from low-income EM, and these economies are precisely the ones most likely to be held back by higher oil prices, fuel rationing, and pressure from subsidies. If they are forced to cut imports, China’s shipments to these markets are likely to be affected first.
Although China is stable, many countries in the region do not have as much of a buffer in refined petroleum products, fertilizers, chemicals, and electricity.
But if we take a longer view, the outlook may not be so bleak.As long as this shock pushes energy security back to the top of countries’ policy agendas, subsequent capital expenditure will tilt toward power-generation equipment, power grids, energy storage, electric vehicles, and batteries...
From 2019 to 2025, China’s actual output of new energy vehicles, solar cells, and power-generation equipment grew by 240%, 340%, and 1080%, respectively, Once overseas markets begin addressing energy security and the green transition at the same time, China may instead reap greater external-demand benefits after 2027.China therefore faces not a one-way negative shock, but rather a situation in which it is initially weighed down by global demand and vulnerable EM in the short term, then recoups some incremental growth from energy-security investment in the medium term.
Chart: Vulnerable economies will weigh on external demand in the short term
Chart: But in the medium term, if countries double down on energy security, China’s supply capacity in new energy vehicles, batteries, and power-generation equipment may benefit
This is also a core source of medium-term tradability.
These sectors can be expected to continue leading market activity over the next 3-6 months..
Seven. Cross-checking the different threads
Overall, in my view, China is now trading more on a complex scenario of “partial insulation, partial benefit, and partial delay” than on a simple bullish or bearish story.In aggregate, China is more stable than most Asian energy-importing economies. On prices, PPI and the GDP deflator recover first, while transmission to CPI and core inflation is limited. On policy, exchange-rate stability takes priority. By sector, upstream industries benefit while downstream margins are squeezed. For external demand, the short-term focus is on the import capacity of vulnerable emerging markets, while in the medium term the question is whether energy-security investment will once again amplify China’s supply advantage.
Everyone, keep a close eye on these indicators:
1) After PPI turns positive, do downstream profit margins deteriorate significantly?
2) Is renminbi stability accompanied by a continued rise in the foreign-exchange settlement ratio, rather than being propped up by stronger intervention?
3) Can the improvement in high-frequency physical demand for commodities such as copper spread from one or two products to a broader range of industrial supply chains?
4) Whether external-demand pressure falls on Asia’s manufacturing supply chain or on import demand from low-income EM
If these factors all move in unfavorable directions at the same time, China’s current recovery will return to the old problem of “insufficient growth.” Conversely, if they all produce positive results, the Chinese market will remain a relatively strong-performing investment bet.
Figure 8: Foreign-exchange inflows and exporters’ willingness to convert foreign currency into yuan are still improving. This shows that yuan stability does not depend entirely on administrative controls; it continues to have fundamental support.
So a more accurate description is that China is not facing a typical stagflation shock in line with those in Europe and the United States. Rather, this is a repricing that is more tilted toward nominal recovery, led by upstream sectors, with policy taking effect later and industries being reshuffled. It will not immediately pull China into a recession trade, but it is enough to bring the market’s previous, straightforward bullish trading framework to a halt.
A new trading rhythm has begun.
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(End of article)
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