Focus
November 15, 2024 | 14:05
Can China ‘Trump Proof’ Its Economy?
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Can China ‘Trump Proof’ Its Economy?A sharp hike in U.S. tariffs would be an unwelcome development given the weakened state of China’s economy. Thus, one should expect Beijing to continue shoring up growth along a number of fronts in the coming months. |
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China’s authorities have ramped up efforts to boost the struggling economy. Although many China watchers were seemingly disappointed with the latest stimulus measures, providing local governments (LGs) a rather hefty CNY10 trillion (8% of 2023 GDP) in debt relief is significant. Nonetheless, Beijing still needs to do much more as it faces the prospect of U.S. President-elect Donald Trump following through on his pledge to raise U.S. tariffs to 60%-to-100% on all imported goods from China. |
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Domestic Woes GrowAn across-the-board tariff hike will be deeply problematic for China given that exports have been the economy’s key source of support since the pandemic. The economy remains bifurcated, with domestic-oriented activities depressed (e.g., consumer spending and housing), while exports and tech-related sectors have proven resilient. Indeed, October trade statistics show merchandise exports (+12.7% y/y) continue to outpace imports (-2.3% y/y) by a wide margin, where the latter is often considered a good barometer of the state of the domestic economy (Table 1). Otherwise, retail sales, which grew a better-than-expected 4.8% y/y in October thanks in part to the government’s expanded trade-in scheme for appliances and automobiles, remains a big concern. Although the benchmark urban unemployment rate stood at 5.0%, in line with the long-run average, it’s widely believed to not accurately reflect the true nationwide situation. Various private sector surveys and anecdotal reports suggest wage growth is much softer compared with pre-pandemic times. The relatively glum state of the broader economy is perhaps best highlighted by the plunge in industrial profits (-27.1% y/y in September). This explains why the spectre of deflation continues to persist with headline CPI rising just 0.3% y/y in October. Thus, the timing of potential U.S. tariff hikes, which could start in early 2025, is not ideal and gauging the impact is not easy. Beyond the negative effects on exports, much will also depend on how Chinese and multinational firms react; that is, whether they decide to deploy/relocate more manufacturing outside of China. Recall, we recently estimated that a 60% U.S. tariff would reduce our baseline real GDP growth forecast for China from 4.5% to 2.0% in 2025 via the direct trade channel (-1.0 ppt) and lower manufacturing-related investment (-2.0 ppts), offset by some fiscal stimulus (+0.5 ppts). However, this estimate is subject to a large margin of error as much would depend on Beijing’s policy response, specifically any in-kind retaliation, greater-than-expected fiscal stimulus, or allowing the currency to depreciate. The Big Fix Is On?It was evident even before Trump won that China’s authorities recognized the urgent need to revitalize the local economy. This was shown by the late-September policy blitz (which included cuts to interest rates and reserve requirement ratios, easing of restrictions on homebuying, stock market support, etc.) and the latest LG debt relief plan. Indeed, it is clear to us that Beijing is embarking on a three-pronged plan to counter potential Trump tariffs: (1) shore up the domestic economy, (2) increase diplomacy with the U.S. and other major trade partners to improve trade ties, and (3), if all else fails, let the currency weaken. All three avenues have their own challenges. Local Governments Rescued Again |
Revitalizing the domestic economy will be difficult, simply due to the fact that the country is grappling with a large debt overhang accumulated over the past decade. Table 2 shows that the country’s LGs and their local government financing vehicles (LGFVs) account for the majority of general government debt, at 32% and 48% of GDP in 2023. Note LGFVs are the key off-budget entities that LGs have relied on to build physical infrastructure, though they have increasingly engaged in other activities (e.g., manufacturing, healthcare, technology, etc.). Moreover, the size of public-related debt is very large (~200% of GDP) if we include non-LGFV state-owned enterprises, which account for a significant share of total corporate debt (~80% of the total). |
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The central government has long wanted to break the belief that it will always rescue sub-national entities and force LGs to independently solve their own financial problems in order to improve nationwide fiscal discipline and reduce moral hazard. On the flip side, LGFVs believe they should be supported by LGs, while LGs believe they should be supported by the central government. LGs argue that they are placed in a difficult position because they collect little revenue compared to the central government but are responsible for most major expenditures (i.e., health, education and infrastructure). Complicating matters, LG revenues have suffered from the housing-led drop in land sales, which has resulted in a bigger funding gap, leaving them more reliant on transfers from the central government. Nonetheless, it should come as little surprise that Beijing provided LGs greater leeway by allowing them to raise their debt ceiling by CNY6 trln and issue another CNY4 trln in special-purpose bonds over the next five years. The central government really had no choice, as was the case in prior debt relief episodes. The LGs will be able to use the funds to absorb/repay maturing debt of LGFVs (i.e., debt swaps) and settle a rising stock of arrears to their suppliers. Housing Doldrums Persist |
The housing market, estimated to account for 25% of economic activity, is likely to remain the biggest drag on the economy. Consumer spending will remain depressed on account of the negative wealth effect from the prolonged downturn in housing prices (Chart 1). Meanwhile, many property developers are still facing financial troubles, which are having knock-on effects for the entire real estate supply chain as they are having difficulty paying their suppliers. The IMF stated in late summer that “about 50% of the country’s developers are still grappling with solvency and viability concerns, while an additional 15% are facing liquidity problems”. Encouragingly, new home sales (in volume terms) have gained some traction following the policy blitz, declining only 0.6% y/y in October. However, it could take a couple more years before the housing market is back on a sustainable footing as a number of factors are holding back the recovery. Notably, property developers remain saddled with a large stock of completed-unsold housing units (Chart 2). However, unlike the 2014-16 period, when developers faced a similar glut of unsold housing, they are also still struggling to complete a massive amount of pre-sold units. The IMF stated in August that “unfinished presold housing as of end-2023 amounted to eight times the 2023 completion rate”, equivalent to 53 million units (Chart 3). It’s also likely that a sizeable portion of these units were purchased by investors and may ultimately end up being listed upon completion. Otherwise, housing demand may continue to feel the headwinds from changing demographics (i.e., shrinking population because of the prior one-child policy). As a result, we still think Beijing will need to introduce more property-related policy support to absorb the housing glut. |
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Potential Policy ResponsesMost China watchers have been disappointed by the lack of above-the-line fiscal stimulus (e.g., tax cuts, greater spending on infrastructure, etc.) following Trump’s victory. Although Beijing has indicated it has more measures in store, we do not expect a 2008-like fiscal bazooka even if 60%+ tariffs are implemented. This is because the country simply does not have the same infrastructure needs as it did 15 years ago. Moreover, widespread cash handouts would only provide temporary relief. Instead, the authorities, as alluded to in the Third Plenum, may begin to focus more on improving the social safety net (e.g., healthcare, education, pensions, etc.) and lowering income inequality, which would do more to lift consumer spending/lower the propensity to save. |
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Otherwise, China’s authorities appear to be increasing efforts to fend off growing protectionism from the U.S. and elsewhere in the world. There are reports that Beijing is considering unilaterally cutting its import tariffs and increasing foreign access to various sectors. Although one can’t completely discount the possibility of Washington and Beijing hammering out a new trade deal, we believe the more likely outcome is that Trump follows through on his tariff pledge as his latest appointments (many of whom are China hawks) suggest he will take a hard line on China. |
The group of Chinese policymakers who face the biggest dilemma if Trump hikes tariffs sit in the central bank (PBoC). It seems reasonable to believe the PBoC would let the yuan depreciate to offset some of the impact (Chart 4). However, the PBoC is unlikely to allow a sudden devaluation commensurate with the increase in tariffs, particularly if they are lifted to 60%+, as this would carry significant risks; namely, strong capital outflows and financial instability. Though Beijing has been constantly tightening capital controls since the sharp decline in foreign exchange reserves in the mid-2010s, money still finds ways to escape. A surge in capital outflows could erode the banking sector’s deposit base and constrict domestic credit. This would place more pressure on Chinese banks, where concerns over asset quality have risen given ongoing difficulties facing the aforementioned housing and LGFV sectors. Reflective of such pressures, banks are being forced to lend greater support via regulatory forbearance (e.g., favourable refinancing, restructuring of loans). |
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Key Takeaway: China has a tough road ahead with risks clearly skewed to the downside. While the impacts of a potential hike in U.S. tariffs are difficult to estimate, it’s clear that China’s real GDP growth and currency would come under increased pressure—and intense pressure in a 60% tariff world. |