Why US trade war is less to blame for China’s economic slowdown than the home-grown deleveraging campaign

The Chinese economy is confronting a double whammy of stiffening domestic conditions and the trade war with the US. Economic growth has slowed noticeably in recent months, particularly in infrastructure investment and credit supply, while financial markets have suffered setbacks, with both equities and the yuan retreating to near 2016 lows. Talk of an economic hard landing has resurfaced, amplifying the recent sell-offs in Chinese and wider emerging markets.

Intensifying domestic constraints have been the main reason for the economic slowdown to date. While trade tensions have dealt a heavy blow to investor confidence, their impact on trade activity, and hence growth, has so for been limited. China’s exports to the US have risen 12 per cent on average over the past three months, in line with growth in total exports.

Instead, this slowdown is home-made, driven almost entirely by a marked tightening of monetary and fiscal conditions. The latter is, in turn, a result of the deleveraging campaign making inroads into the real economy. Contrasted with the early phase of the operation, which focused on trimming the fat off the financial system, the deleveraging campaign has started to tackle debt in the real economy this year.

The most noticeable area of restraint is in the official sector, where debt accumulation – in the form of bond issuance and shadow-banking credit supply – slowed dramatically in the first half of the year. The government’s off-balance-sheet activities have also been curtailed by the withdrawal of financing guarantees for local government funding vehicles (LGFVs) and the termination of many private-public-partnership projects.