China’s economic reforms are working. The bad news is the pain may get worse
- Aidan Yao says amid a growth slowdown, the strengthening service sector and household consumption are welcome news. Even so, softening global demand and challenging conditions at home will keep economic planners on their toes
Yet, despite the overall economic slowdown, rebalancing of the growth model has continued. According to the National Bureau of Statistics, the service sector now accounts for 52 per cent of the economy and has continued to grow at a solid 7.6 per cent. That is 1.8 percentage points and 4.1 percentage points faster than the secondary and primary industries respectively.
On the expenditure side, consumption remains the largest growth contributor, making up 76 per cent of fourth-quarter GDP growth. The bureau noted that service-related transactions now account for more than 44 per cent of household consumption, making them a critical component for gauging the health of the household sector and the overall economy.
However, given the lack of high-frequency indicators, our reading of this rapidly growing part of the economy is often delayed and incomplete. This could explain, at least partially, why the GDP data can sometimes present a different growth picture from that of monthly activity data, which has service-sector coverage.
This is a good start towards unclogging the monetary transmission channel that enables the abundant liquidity in the financial system to nurture growth in real sectors. But this work is far from done. The People's Bank of China and other regulators need to ensure monetary policy strikes the right balance between near-term growth support and medium-term risk management (for example, deleveraging).
Looking ahead, even though China’s 2018 GDP growth came in above Beijing’s “around 6.5 per cent” target, the job of engineering a soft landing for the economy is far from over.
Of the major economic headwinds anticipated in 2019, external factors have barely begun to gain force, and the worst of their impact is yet to come. China’s export growth is likely to tumble further in the first quarter due to a combination of paybacks for previous export “front loading”, US tariffs, and a slowdown in global demand.
Internally, weak business confidence, particularly in the private sector, is a worry as firms may choose not to spend or invest even if they get cheap credit and tax relief.
The housing market is another time bomb that will require defusing. For now, resilient construction activity is supporting the economy, but it is only a matter of time before momentum fades, given the softness in housing sales and restraining policies. A housing market correction will affect household consumption and local government finances (via land sales), undermining the efficacy of fiscal stimulus measures.
Overall, there are plenty of obstacles ahead, and there is no room for complacency. Senior officials in Beijing are aware of these challenges, and have been boosting policy support accordingly.
We should expect more value-added-tax and fee reductions for small and medium-sized enterprises, along with further boosts to infrastructure and household spending. The central bank is also becoming more proactive on monetary policy, emboldened partly by the recent drop in pressure on the renminbi and capital outflows. Two to three cuts in the reserve requirement ratio are forecast this year, with the next one possibly as early as March.
If a trade deal is struck with the US and domestic weakness deepens, cuts to benchmark interest rates cannot be ruled out.
Aidan Yao is a senior emerging Asia economist at AXA Investment Managers
