Recent developments in China

 

Economist's View

High among concerns surrounding the global outlook has been the slowing of growth in China. This was highlighted last month when China’s national accounts data for Q4 2018 revealed annual growth had slowed to 6.6% which, while meeting its official target (of around 6.5%), was nonetheless the slowest pace since 1990. Despite the negative headlines, the data suggested only a mild slowdown from growth of 6.8% in 2017 (and was in line with our 2018 forecast for Chinese GDP growth this time last year). However, more timely indicators of activity in the Chinese economy indicated a more substantial loss of momentum through 2018. In this week’s Brief, we discuss what’s been driving the slowdown, what actions are being taken by authorities to address slowing growth, and our outlook for the Chinese economy this year.

Slowing growth in China is not unusual or unexpected, given the falling potential growth of the economy, however the slowing in momentum appeared to gather pace through 2018. Growth of industrial production and retail sales trended lower through the year, while annual growth in urban fixed asset investment slowed markedly, driven by a particularly sharp decline in growth of infrastructure investment. Manufacturing PMIs have fallen below 50, indicating slowing momentum in the manufacturing industry. One culprit is the escalation in trade tensions between the US and China. Although we think the direct economic effect of the tariffs currently implemented are small so far, the tensions have clouded the outlook and likely weighed on confidence, while also having a clear effect on China’s trade.

In addition, much of the slowing in momentum has been policy led, reflecting intentional and expected policy tightening as authorities seek to contain risks in the financial system. The first half of 2018 saw authorities continue with deleveraging efforts such as tighter regulation of financial products and local government financing, which had seen higher interest rates and defaults, and a slowing of credit growth (including local government borrowing). Increased regulation aimed at containing lending through shadow banking channels has restricted lending particularly to small, private enterprises, also creating a headwind to growth.

Authorities have responded to the slowdown by loosening monetary policy broadly as well as announcing measures more targeted at increasing credit availability to small private firms. The People’s Bank of China (PBC) has continued its path of cutting the reserve requirement ratio (RRR), reducing it a further 100bps since the beginning of the year following 350bps of cuts in 2018. This has maintained liquidity in the financial system, and saw money market rates fall in mid-2018 and remain low since. The PBC has extended its medium-term lending facility (MLF), and also introduced a new targeted MLF with longer maturities for the purpose of increasing bank lending to private and small businesses at lower rates.

Authorities have also responded to slowing growth on the fiscal side, though as with the monetary easing seen to date, the policy response so far has been modest and more targeted compared with previous periods of stimulus. Authorities have announced further personal, corporate and R&D tax cuts in order to stimulate spending and activity. The State Council has announced temporary personal income tax deductions relating to education, health care, housing, and aged care, as well as an increase in the tax-free threshold. On the business side, the VAT rate has been lowered for a number of industries including manufacturing, transportation, construction, telecommunication services and farm produce, and authorities have broadened the scope of tax deductions for R&D spending.

There has also been some response in the form of direct fiscal spending, particularly infrastructure investment. Authorities have signalled support for local governments to accelerate transport infrastructure investment, and have recently stepped up approvals of transport projects, including rail extensions. Earlier attempts from authorities to encourage local governments to accelerate bond issuance for financing infrastructure projects seem to have been effective, with local government issuance rising through the latter half of 2018.

There are some early signs of stabilisation in momentum in the Chinese economy and that policy support is having some effect. Recent data suggests the slowdown in fixed asset investment growth has bottomed, aided by a pick-up in infrastructure investment in recent months, while year-ended growth in retail sales and industrial production both arrested their declines in December (albeit only marginally). In addition, recent messaging from authorities (including President Xi Jinping and Premier Li Keqiang) has reaffirmed the likelihood of some continued policy support for the economy in the face of slowing growth.

What does this all mean for China’s economy this year? We expect growth to ease to 6.2% for 2019, representing a moderate rather than a rapid slowdown, though risks to the downside have risen. Our view is that authorities would respond further to prevent a sharp deterioration in growth, particularly if risks such as the US-China trade war escalate sharply, but they will still seek to maintain their policies aimed at containing risks in the financial system and the build-up of leverage. Over the medium term, it is these risks that we believe pose a greater threat to the outlook for China’s economy, and authorities will continue to face a challenge to balance short-term support for the economy and further structural reform.

Table 1: Financial market movements, 7 – 14 February 2019

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,745.7

1.5%

US

2.65%

-0.4 bps

US Dollar Index (DXY)

96.98

0.5%

Nikkei 225

21,139.7

1.9%

Japan

-0.01%

-0.6 bps

USD-JPY

110.48

0.6%

FTSE 100

7,197.0

1.5%

UK

1.15%

-2.7 bps

GBP-USD

1.280

-1.2%

DAX

11,089.8

0.6%

Germany

0.10%

-1.2 bps

EUR-USD

1.130

-0.4%

S&P/ASX 200

6,059.4

-0.5%

Australia

2.15%

-0.3 bps

AUD-USD

0.711

0.1%

Source: Bloomberg

 

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