The Outlook: January 2019 economic commentary
Concern over a slowing Chinese economy is unnerving investors. It seems that hardly a day goes by without a large corporation blaming weak sales in China for disappointing performance.
The imposition of US trade tariffs is taking its toll on external demand, while weaker investment spending and falling car sales suggest domestic demand has not picked up the slack. With the world’s second largest economy having made a disproportionate contribution to global growth in recent years, a Chinese ‘hard landing’ would be seriously bad news. But how worried should we be?
The economic data out of China has undoubtedly been ugly of late. Annual gross domestic product (GDP) growth slowed to a post-crisis low of 6.5% in Q3, and data during Q4 points to a further deceleration. Manufacturers have been hit by the imposition of US tariffs and slowing global trade, with Chinese exports falling 4.4% year-on-year in December. Manufacturing PMI data for December revealed the first contraction in the sector since May 2017, as foreign orders fell back.
Meanwhile, investment spending has been unexciting, not least as Beijing has sought to rein in leverage and promote financial stability following years of lenient lending practices that prevailed in the wake of the financial crisis.
A collapse in Chinese consumption?
Moreover, the headlines regarding the consumer sector have raised doubts about the authorities’ bid to rebalance the economy away from a dependence on external demand and investment towards household spending. Apple recently cited disappointing iPhone sales in China as the main factor behind its first profit warning since 2002. Car sales fell 13% in December, resulting in a drop for the year as a whole of 2.8% - the first annual decline since 1990.
However, there is some evidence to suggest that these developments might overstate the underlying slowdown in Chinese consumption. Disappointing iPhone sales in China are in part a reflection of smartphone users turning to cheaper domestic alternatives, and there is also the suggestion that the US-China trade spat has prompted an informal boycott of Apple products. Recent weakness in car sales has partly been a result of the expiry of tax incentives on smaller cars. Falling car sales pulled down overall retail sales growth to a 15-year low of 8.1% year-on-year in November, but excluding autos, growth in retail spending has been fairly stable at around 11% year-on-year.
In addition, as Chinese consumers become wealthier, they are spending more on services, which are not included in the retail sales data. In recent years, the service sector has grown to become the largest sector in the economy and is making an increasingly significant contribution to GDP growth. Indeed, in contrast to the recent weakness in manufacturing, the services PMI showed growth accelerating to a 6-month high in December.
Pressure for a deal
One potential silver lining resulting from recent poor economic data is that it gives the Chinese authorities a clear incentive to reach a trade deal with the US. Beijing has made some concessions in recent weeks, including a pledge to buy more US agricultural products, a reduction in tariffs on American cars and improved protection for intellectual property. However, disagreements over China’s industrial policy are proving more difficult to resolve.
In the absence of a deal, or at least an agreement to extend the current trade truce, the Trump administration is scheduled to impose increased tariffs on $200 billion of Chinese imports on 2 March. With such a move likely to damage both the Chinese and US economies, and usher in renewed global equity market volatility, both President Trump and President Xi Jinping are under pressure to compromise.
A managed slowdown
Another reason not to get too pessimistic about China is that the authorities are loosening policy in a bid to cushion the slowdown. The People’s Bank of China has eased lending conditions by cutting the amount of reserves that banks are required to hold, while also encouraging banks to make loans to smaller companies. As regards infrastructure spending, Beijing has accelerated the approval of new rail projects and expects to add 6,800km of new lines this year, up 40% on 2018 levels.
Tax cuts for households and businesses are also being introduced. Estimates suggest that cuts to individual income taxes, which come into effect in January, could reduce households tax burden by around 0.5% of GDP, potentially providing a significant boost to spending.
This does not mean that we should expect to see Chinese growth pick up significantly later in the year. Beijing’s focus has shifted to achieving sustainable growth, rather than achieving elevated growth targets at any cost. A repeat of the huge stimulus in the wake of the financial crisis, which prompted a boom in infrastructure spending and left the country burdened with debt amounting to over 250% of GDP, is unlikely to be forthcoming. Reports suggest that the government is looking to set an economic growth target for 2019 of 6.0-6.5%, which would mark a further downshift from the expansion in 2018, which is estimated at around 6.6%.
Recent history has shown that China has an uncanny knack for meeting its growth targets. This is in part due to the questionable accuracy of official economic data. But it is also a result of Beijing’s relatively unfettered capacity to adjust policy if the economy weakens more than expected. Such policy freedom contrasts sharply with the restraints faced by President Trump, who has recently railed against the US Federal Reserve for raising interest rates, and has seen plans for a border wall blocked by Congress.
There is little doubt that China’s economy faces considerable long-term challenges, including elevated levels of debt, overcapacity in certain industries and an ageing population. In the near-term, a re-escalation of the US-China trade war remains a downside risk. And with the composition of the economy shifting away from a reliance on manufacturing and investment, and towards consumption and services, some corporations will continue to complain of disappointing Chinese sales. However, if a full-blown trade war is avoided, the story for 2019 is likely to be one of ‘managed slowdown’ rather than ‘hard landing’.
This article is for generic information only and is not suggesting a suitable investment strategy for you. You should seek independent financial advice that takes your individual circumstances into account prior to proceeding with any course of action.