Focus
January 10, 2020 | 12:35
China’s 2020 Economic Outlook: Looking Better?
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Fixed Income Strategy
Economics
China’s 2020 Economic Outlook: Looking Better? |
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Predictions that China’s economy is heading for an imminent ‘hard landing’ are receding on the heels of Beijing and Washington’s Phase One trade deal. The de-escalation in the trade war will ease pressure on China’s economy but, in our view, is unlikely to trigger a sustained turnaround. We forecast headline real GDP growth to steadily slow, to 5.9% in 2020 from an estimate of 6.1% in 2019, as the economy continues its transition from an investment/manufacturing-driven model to a more consumption/service-based one (Chart 1). In addition, the hefty build-up in financial leverage is likely to continue to weigh on the economy, which is reflected by the recent struggles of a number of small and medium-sized banks. U.S./China Trade War Détente…The Phase One trade deal is good news for China, the United States and the world economy all around. Financial markets have responded favourably with both the renminbi and the benchmark stock market—the CSI 300—rallying since the announcement. Leaving aside the debate of who got the upper hand, the most critical aspect of the Phase One agreement is that: (1) it has led to a de-escalation in the trade war; and, (2) it has reduced the risk of long-term economic decoupling between the two adversaries. Nonetheless, permanently resolving the trade dispute is likely to remain difficult given America’s growing concerns over China’s heavily managed/state-driven economy. There is still a possibility that the trade war re-escalates in 2020, as resolving the differences over Chinese industrial subsidies and market access is likely to remain highly contentious. Conversely, it was encouraging to see that the Phase One deal reportedly addressed U.S. concerns over intellectual property and technology transfer. …Will Ease Pressures on the EconomyAlthough the Phase One deal is unlikely to reverse China’s economic slowdown, it should alleviate some pressure. According to the Peterson Institute for International Economics, the average U.S. tariff rate on imports from China will edge down to 19.3% from 20.9%. Without the agreement, U.S. tariffs would have climbed to 25%, compared to just 3% prior to the trade war. The deal should provide a lift to China’s manufacturing sector, which has been hit quite hard. Industrial production has risen by an average of just over 5.0% y/y in recent months, the slowest in over a decade (Table 1). In tandem, the manufacturing purchasing managers’ index (PMI) has struggled to stay above the critical expansion/contraction mark of 50 in 2019, though it climbed to 50.2 in November and December. The rest of China’s economy is in better shape, highlighted by a non-manufacturing PMI that is firmly in the expansion zone. This reflects the relative resilience of the construction and services sectors, which helps explain why China’s new benchmark survey-based unemployment rate has remained stable in the face of ongoing job losses in the manufacturing sector. Retail sales climbed 8.0% y/y in November (vs 7.2% in October) despite a continued contraction in automobile sales. The latter is still suffering from a change in emission standards and the unwinding of a previous tax break. Meanwhile, the housing market continues to underpin construction activity. Nominal fixed asset investment in real estate grew 9.2% y/y in November, while the new housing price index (for 70 major cities) increased 7.1% y/y (Chart 2). Housing Speculation Still Being Tackled…Although some smaller municipalities have reportedly made it slightly easier to buy homes, larger cities remain under pressure to maintain housing restrictions, which were tightened in late 2016. Beyond clamping down on housing via demand measures (such as sales restrictions applied to non-locals and lower mortgage loan-to-value ratios), Beijing has recently started to constrain property developers’ funding channels. Financial institutions have been told to limit lending to developers and Beijing has curbed their ability to issue bonds offshore. Meanwhile, a range of authorities have repeatedly stated that “homes are for living, not for speculation” more frequently over the past year. |
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…To Address Financial StabilityA stable housing market should not only support economic activity but also the government’s broader objective of maintaining financial stability, which remains a source of concern given the tremendous leverage [1] built up in the aftermath of the Great Recession. In our view, Beijing’s longer-term objective of curbing leverage and enhancing financial transparency (i.e., de-risking) remains intact. Evidence of ongoing de-risking efforts is shown by the continued decline in shadow banking activity in China (Chart 3). In addition, Beijing is expected to designate a number of larger banks (at least 10) as domestic systemically important financial institutions (D-SIFIs) in 2020, which will likely force these entities to increase their capital buffers to guard against potential systemic stress. Thus, we still do not view the recent troubles/rescues of a number of smaller banks (among the country’s 4,000+ lenders) as a sign that the country is facing an imminent banking crisis. In our view, there are likely a number of small city/rural banks currently facing difficulties related to asset quality/nonperforming loans, a legacy of the credit boom that took place in the aftermath of the Great Recession. From a systemic risk perspective, the chance of widespread contagion developing from the failure of a small- or medium-sized bank appears limited, as their credit exposure and operations are highly localized. Key TakeawaysThe risk that China’s economy could slip into a deep recession has fallen. Moreover, the current economic situation does not appear to be much worse than during the last downturn in 2015/16, which was highlighted by the bursting of the stock market bubble and the mini-devaluation of the renminbi. Back then, we were more concerned over a possible hard landing as Beijing was still pursuing a ‘growth at all costs’ strategy and had not yet begun to tackle financial stability risks with much vigour [2]. At the same time, the Phase One deal will ease pressures on Chinese policymakers to significantly loosen policy settings. We now expect both the Ministry of Finance and the People’s Bank of China to continue tweaking fiscal and monetary policies, instead of introducing large-scale countercyclical stimulus. Reflective of this strategy, the central bank lowered the commercial banks’ reserve requirement ratio by 50 bps on January 1st, which was the eighth cut since early 2018. |
Endnotes:[1] Bank of International Settlements estimates that total credit to the private non-financial sector credit stood at 209% of GDP in Q2/19, compared to 116% in Q4/08. [^][2] Note that the ‘financial deleveraging campaign’ was first introduced in late 2015 as part of the 'supply-side structural reform' program but only rose up the priority list in early 2017 when President Xi pronounced that ‘financial security is an important part of national security’. [^] |