What does a potential China growth scare portend?
20 March 2019 | Markets and Economy
Commentary by Qian Wang, senior economist at Vanguard in the United States.
With US-China trade talks in the limelight, investors have been paying close attention to economic developments in China. Amid signs of progress, President Trump last weekend extended a 1 March deadline for increasing US tariffs on USD $200 billion of Chinese goods to 25% from 10%.
2019 forecast: Bearish first half, more stable second
Economic implications of the two countries' trade war have become increasingly evident, with China's GDP slowing to 6.4% in the fourth quarter of 2018—its third consecutive quarterly decline.
Chinese policymakers promptly responded with a series of stimulus measures intended to protect short-term economic stability. These measures will take time to work through the economy and may not be as effective as in previous slowdowns, given the elevated leverage in the economy and structural differences in the drivers of this slowdown.
Vanguard expects China's GDP growth to be a bit slower than the consensus estimate for the first half of 2019 but to average about 6.1% for the full year; for 2018, it was 6.6%.
China GDP growth
Forecast below consensus for first half of 2019
Sources: Thomson Reuters Datastream, CEIC Data, Bloomberg, and the National Bureau of Statistics of China.
China's growth derives from two economies:
- An old economy based on state-owned enterprises, low-end and heavy manufacturing industries such as textile, coal, steel and concrete production, as well as real estate.
- A new consumer-driven economy led by private enterprises and reflected by domestic consumption, high-skill manufacturing and service industries.
Our bottom-up growth model based on micro-industry indicators shows that weakness in the new economy is primarily driving the current slowdown.
Stimulus measures that proved effective in 2015 and during other old-economy slowdowns—measures such as overall liquidity and credit easing, as well as administrative orders for state-owned enterprises to increase investment and production—wouldn't likely be as effective or efficient in stimulating the new economy.
What's required instead are measures that boost domestic sentiment and incentivise private enterprise. We believe the recent stimulus measures taken by Chinese policymakers will deliver. Hence, we view a China hard landing in 2019 as unlikely.
Implications for the global economy and markets
China has proven its ability to roil the global economy and financial markets. Memories are still fresh of 2015, when Chinese equities fell more than 40% in just over two months and the country lost $1 trillion in foreign currency reserves.
The relatively good news this time, however, is that the spillover effects through financial channels will be less severe because of capital controls implemented in recent years. These controls reduce the risk of large-scale capital outflows and heightened currency depreciation pressure, such as those witnessed in 2015–2016, and thus help head off a surge in global risk aversion.
In terms of economic growth, emerging-market countries will be hit hardest by the anticipated slowdown in China. The impacts are expected to be in the range of –0.10% to –0.20% for the United States but as high as –0.49% to –0.64% in Asian and Latin American emerging markets. Japan and Europe will also feel the sting from export-related weakness.
Will growth scare spur a US-China trade deal?
Despite policymakers' efforts to stabilise domestic growth, the trade conflict with the United States remains a wild card.
In the short term, the pause in tariff escalations may persist while negotiations on long-term structural issues continue. A partial deal may result that could involve a significant rise in imports from the United States, easing restrictions for foreign firms and creating more equal tariff alignment. These developments would likely boost market sentiment and reduce the probability of a China growth scare this year.
However, caution is warranted over a longer time horizon. The scope of US-China disagreements extends beyond trade to such areas as investment, technology, intellectual property rights, market access and industry policy. Although China has expressed intentions to make fundamental structural reforms in these areas down the road, it will be challenging to meet the pace and magnitude of changes desired by the US administration. Therefore, the US may use the pressure of further escalation to pursue a later deal on long-term issues. Chinese policymakers will remain on alert and be ready to deliver additional stimulus measures should the situation sour.
I'd like to thank Adam Schickling, CFA, a junior economist in Vanguard Investment Strategy Group, for his assistance with this post.
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