Rising external pressures force Beijing to recalibrate its macroeconomic policies

China’s economic policies are facing rising external pressures and are consequently being adjusted. This year of managed economic slowdown has been marked by slowing infrastructure investments, and slowing property sector and bank credit growth. Export growth also decreased due to a deteriorating global trade environment but temporarily accelerated as of the third quarter in anticipation of higher US import tariffs. All those developments reflect the two dominant economic risks the country faces for the years to come, which will greatly shape Beijing’s future policies: the structural reduction in its huge domestic debt and the US trade war against China.

The 2019 macroeconomic outlook promises to be more challenging for the government. The US trade war has just begun and will start to bite as from next year, especially as it is expected to escalate. Import tariffs are expected first to be raised next January from 10 to 25% on the currently targeted goods imported from China (amounting to USD 250 bn, i.e. roughly half of the total), and secondly could be extended to all Chinese exports to the US. Therefore, the key government priority will be to stabilise the economy by means of various stimuli and support to economic players, as already seen over the past months, from exporting companies to consumers (notably via income tax cuts), and from state-owned to private enterprises. To do that, the central government has room for fiscal manoeuvre with a budget deficit and general government debt forecasted respectively around 4% and 50% of GDP in 2018 before climbing to 4.4% and 53.9% in 2019.

Broad and moderate domestic stimuli should mitigate the US trade war impact

In addition to fiscal stimuli, the monetary stance will be increasingly accommodative, with further potential cuts in banks’ reserve ratios and rising bank credits. The latter’s growth has indeed fluctuated at lower levels this year (around 12-13% y-o-y) partly as a result of an effective crackdown on shadow banking. Moreover, in the context of rising US protectionism, Beijing is keen on profiling itself as a pro-globalisation and free trade country – as opposed to the current US policy – and will selectively promote foreign investment by being more open to them in a range of sectors, from the car industry to banking and insurance. At the same time, as a way to further support the consumers’ purchasing power and face rising social expenditures related to an ageing population, the government has announced a further expansion of the social security system, thereby confirming the official choice for more sustainable policies.

All in all, private consumption, public spending and local government investments should bring a large contribution to supporting GDP growth in 2019 and partly compensate the impact of US protectionist measures. In a more adverse economic climate, GDP growth is forecasted to drop from 6.6% this year, i.e. its lowest level since 1990, to 6.2% in 2019. The IMF estimated that mounting US trade tariffs could reduce GDP growth by at least 0.5%. Although this is far from insignificant, it shows that trade tensions should be manageable for Beijing particularly since net exports are no longer driving GDP growth.

Domestic deleveraging to slow down, non-payment risks to remain high

In spite of the announced stimuli, which will be broad but moderate, Beijing will ensure to hinder domestic debt rise in order to preserve sustainability goals. The rapidly increasing household debt – from 40% in early 2016 to currently around 50% of GDP – which has more than offset the encouraging small decline in non-financial corporate debt, has further fuelled the total non-financial debt bubble to more than 260% of GDP.

As frequently seen during the economic rebalancing process, the Chinese authorities give a boost to the economy when the economic context deteriorates, which is happening at the moment. It could mean allowing the deleveraging process to make a break or at least mitigating it. Meanwhile, payment delays and non-payment risks for non-systemic companies will increase in 2019 as state support becomes less implicit and more selective. This is reflected by Credendo assigning China the highest systemic commercial risk rating of C (on a scale from A to C). Therefore, Beijing has indicated its plan to increase bank loans to the private sector as the latter suffers from systematic weak lending.

A main policy challenge for Beijing in 2019 will be the evolution of the renminbi (RMB). Faced with a strengthening USD, the RMB has lost 7% during the year and should be under rising pressures next year given the diverging monetary policy with a tightening Fed and negative impact of the US trade war. Unlike a still recent past, the People’s Bank of China barely intervened to defend the exchange rate this year, preferring to let market forces play a main role and save its roughly stabilised foreign exchange reserves. This might continue, especially as tolerating a weaker RMB eventually above the threshold of RMB 7 for USD 1, would support exporters’ price competitiveness at a time of higher US import tariffs. However, more interventions – and possibly some capital controls – will probably be necessary to avoid capital flight and potentially declining investor confidence. This year, China has been enjoying rising net capital inflows as non-resident portfolio flows benefit from heightened investment opportunities in a gradually more open financial sector.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com