For China, the worst of the trade war is yet to come – economic growth will decelerate in 2019
- Aidan Yao says it is unlikely that talks between Trump and Xi will resolve the trade war, so investors should think twice before buying into rallies
- With China’s ability to stimulate the economy hampered by the desire not to reverse reforms, growth may slow to 6.1 per cent in 2019
It has been a challenging year for the Chinese economy and markets. What got off to a positive start, following the strong momentum of 2017, quickly gave way to a rapid deterioration of economic fundamentals and investor sentiment. A sudden turn for the worse in US-China trade relations dealt a heavy blow to Chinese equities and the currency.
In addition, domestic policies, particularly those centred on deleveraging and shadow-banking controls, have also contributed to the negative sentiment by pulling down domestic demand. While macro policies have now been adjusted, they will be inadequate to reverse the negative growth trend in the near term. Hence, the economy is likely to end 2018 at 6.5 to 6.6 per cent growth, the lowest since the global financial crisis.
While 2018 has been challenging, 2019 is not about to get any easier. Externally, the US-China trade war has not yet affected the real economy, due to export front-loading ahead of the implementation of tariffs. These “pre-emptive” purchases, however, will not last forever and the real shock of the trade war is expected to hit home from early 2019.
The baseline case is that a 25 per cent tariff on US$250 billion of goods sold to the US will lower Chinese gross domestic product growth by 0.9 percentage points after accounting for the direct (trade) and indirect (investment and consumption) impacts. If Trump were to initiate a full-scale trade war that imposes duties on all Chinese products, the growth shock would increase to 1.5 per cent of GDP.
However, recent news on the trade front has not been all bad.
Watch: Trump and Xi agree to try and resolve their differences
The markets reacted positively to last week’s conversation between Chinese President Xi Jinping and US President Donald Trump after a long dry spell of no official interactions from both sides. A Xi-Trump meeting at the G20 Summit is almost certain. As the trade war started to bite, causing carnage in both the Chinese and US markets over the past month, it is understandable that the two captains are under pressure to get negotiations back on track.
However, past experience suggest that the bilateral trade talks, even if they resume after the G20 meeting, will not guarantee a solution to the current stand-off. Hence, investors should still be cautious about buying into the rallies.
Besides the trade war, the global growth cycle has peaked and will turn south in 2019. The recent softening of US data is a harbinger of more weakness to come. The euro-zone economy has also disappointed this year and is heading for a further downturn in 2019, even if the current Italian fiscal malaise and Brexit do not impinge on economic growth. These factors will create a tough environment for Chinese exports, with growth expected to grind to a halt in 2019 after a strong year.
Turning inward, China’s domestic conditions will, as usual, be buffeted by the ebb and flow of official policies. Beijing’s supply-side reforms in 2015-2016 and deleveraging operations in 2017-2018 have perpetuated profound changes in the macro environment.
However, the macro backdrop has now changed again, and will require Beijing to adopt a different management tactic. The recent policy easing is a clear sign that the pendulum has shifted towards supporting the economy against mounting growth headwinds.
However, the desire to avoid reversing reform progress will limit Beijing’s ability to stimulate the economy as quickly and aggressively as during the past easing cycles. For example, instead of relying on liquidity and credit policies to supercharge growth in the housing market and infrastructure investment, the government has made more use of fiscal tools to support households and small and medium-sized enterprises via tax and fee reductions.
At last week’s Politburo meeting and a gathering with small-business leaders, Xi vowed “unwavering” support for the private sector and provided clear guidance on where the policy assistance – fiscal, monetary and regulatory – will be implemented going forward.
The strong vocal support lately for private businesses from the very top is unusual, and suggests that a political consensus has been reached on the focus of this round of policy stimulus. More policy easing is likely to come for SMEs in the coming months, with the attention also focusing on the proper execution of existing measures.
Overall, Beijing is expected to maintain the policy mix of “proactive” fiscal policy and “prudent” monetary policy in 2019. Striking a delicate balance between short-term growth and long-term sustainability will not be easy and may come at a cost – in the form of a slower and less vigorous growth rebound than that during previous stimulus cycles.
Therefore, the accumulative policy support – even with more to come – will not be enough to prevent a further growth slowdown, to 6.1 per cent in 2019 from this year’s 6.5 to 6.6 per cent.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers