Should We Really Worry About China?

The recent release of China’s GDP growth of 6.6%—a 28-year low—drew sharp attention. Keywords such as “collapse,” “recession” and “hard-landing” dominated headlines, citing China’s trade tension with the U.S., its stock market crash and Beijing’s crackdown on debt.

Granted, if China’s economic growth is set to crash, the world economy will feel the pain. But is it?

We think not, because the next few years are too important for the economy (or the government) to fail.

  • October 1, 2019 is the 70th birthday of the People’s Republic of China, when a grand celebration shall be arranged, and a strong economy be supported.
  • 2020 is set to be the milestone year of China’s fully achieving “Xiao Kang Society,” defined by 10 basic goals including a Gini coefficient lower than 40% and double the GDP per capita of 2010.
  • July 1, 2021 marks the 100th birthday of the Communist Party of China.
  • The Communist Party will hold its 20th National Congress in 2022 and plan the future development trajectory of the country.

Don’t underestimate the power of political drivers in China. The government and state-owned enterprises have resources to generate profound influence on the overall economy. One roadblock is the lack of liberalization that will hinder China from building a knowledge-based consumer economy, but that is a longer-term issue. Other factors support a revival of the Chinese economy in the second half of 2019, albeit subject to a higher-than-normal degree of risk.

Trade

Nothing will restore confidence and enliven financial markets like a U.S.-China trade deal. Eyes are set on January 30 and 31 when Liu He, President Xi’s top economic advisor, will meet with Robert Lighthizer, the U.S. trade representative. Results of the meeting will largely determine the prospect of a U.S.-China trade deal—a swing factor for the economy, politics and stock markets.

We estimate the probability of a deal is at least 60%, backed by Beijing’s move toward the right direction, the process of which we outline below:

  • Greater understanding:
    • The majority of the Chinese public, including government officials, initially considered the tariff announcements as tactical moves by the Trump administration to broaden access to the Chinese market. This belief diminished in the tit-for-tat tariff escalations, disappointing negotiations and geopolitical conflicts that followed.
    • It has become clear that the conflict is not about trade but the future. As communicated by China’s Ministry of Commerce, Ministry of Foreign Affairs and the mainstream media, the central issues are technology, cybersecurity and market access based on reduced Chinese subsidies and restrictions on foreign companies. This understanding is much closer to their U.S. counterpart’s and will help negotiations go farther.
  • More incentives to make a deal:
  • Currency: The RMB weakened by 6% against the U.S. dollar last year. It has discounted Chinese goods (Figure 1) and cushioned the tariff blows but also created significant pressure on the Chinese government to stabilize the currency and restrict capital outflows.
  • Supply Chain: Chinese manufacturers exported a record level of machinery, equipment and manufactured articles to U.S. businesses, with 7% annual growth.[1] This raised concerns over potential disengagement among existing partnerships.
  • Sentiment: The Shanghai Composite Index sank 26% in value last year and took investor and business sentiment with it. Healthy growth of the financial services sector is critical to solve the inefficient saving glut in China.
  • Employment: Job growth entered the negative zone (-0.3%) for the first time since 1963, dragged down by the manufacturing sector.[2] The government initiated incentives for enterprises to forgo layoffs, but a more effective remedy to stop the fundamental softening of labor market is needed.

On such ground, Vice Premier Liu He, who deeply understands the Chinese economy, has strong incentives to take a more conciliatory approach. Timing is critical. Demand for a trade deal also is peaking in the U.S. before the 2020 presidential election. If Liu He and Robert Lighthizer reach an agreement by March 1, financial markets will react very positively.

Consumers

Policymakers have not fully unlocked the potential of Chinese consumers, who hold the key to China’s structural reform. Import growth decelerated at the end of 2018 (Figure 1) in line with domestic consumption growth, which fell from an average of 10.4% to 8.9%.[1] What happened to the rise of Chinese consumers?

  • The rise of household debt:
  • The household-debt-to-GDP ratio reached 53% last year, the highest in China’s history. By comparison, domestic loans to non-financial enterprises had meaningfully smaller growth, especially since 2016 when the government started to deleverage (Figure 2).[2]
  • China continues to struggle with an inefficient saving glut, while the newly formed middle-income class has taken on much more debt. This has largely prevented double-digit consumer spending growth.

  • Policies have been set in place to boost domestic demand, while also supporting China’s supply-side reform. This is a tricky balancing act:
    • The value of tax cuts topped 1.3 trillion yuan (US$189 billion) in 2018. The program will roll out further in March for individuals and businesses, introducing additional deduction items and lower consumption taxes (VAT). Total value is projected to reach another 1.5 trillion yuan (US$221 billion).[1] The tax relief should bode well with low inflation (2.1%), though its impact may not immediately be seen due to high household debt.
    • The average mortgage rate dropped 0.5% in December after increasing for two years.[2] The government is poised to pause tightening housing demand and strategically support first-time home buyers with lower borrowing costs.
    • Tariffs were cut four times since last year on grand scales for foreign goods and services. For instance, auto tariffs dropped from 25% and 20% to 15% and auto parts down to 6%. President Xi has publicly stated his support of the opening-up reforms.
    • People’s Bank of China is using monetary tools to bolster growth, including Reserve Requirement Ratio (RRR) cuts and more targeted loans for private and small businesses. Additional stimuli are highly anticipated and relatively manageable with high-level policy rates.

Fundamentally, consumer demand is built on wealth. China has a long way to go to become a wealthy nation and there is a bumpy road ahead, but it has come a long way too―a story to be told on its 70th birthday, then again in 2020 as it sits at the heart of “Xiao Kang Society” as defined earlier.

After a slow start, the Chinese government is showing greater willingness to reach a trade deal with the U.S., including a 90-day trade truce, multiple phone calls and offers to meet. We remain cautiously optimistic about the outlook.

Overall, China’s economy will grow by around 6% in 2019, and while the risks are higher than before, the likelihood of a Chinese recession is very low. Chinese political imperatives, and perhaps those of the U.S., will not allow it.

By Professor Richard Barkham, Global Chief Economist & Wei Luo, Senior Research Analyst, CBRE.

[1] Calculated using the monthly data of U.S. Census Bureau through October 2018 and comparing the past 12 months with the prior 12-month period.

[2] Based on employment data from Conference Board TED, and business surveys by Manpower.

[3] Full-year comparison between 2017 and 2018 using monthly data from China National Bureau of Statistics.

[4] Domestic loans were referenced from monetary financial institutions to non-financial enterprises in China only and do not include shadow banking or non-monetary liabilities.

[5] Reported by China Daily and Reuters according to interviews with China’s finance minister.

[6] Mo Hong’e, ECNS, January 2019.