China has a steady hand on its slowing economy, but can it prevent a crash landing?

Policymakers have little room to manoeuvre even if the domestic economy is holding up. With the trade numbers hit hard by US tariffs, their prudent policies won’t go far enough to ease the pain if the external environment does not improve

Aidan Yao

Published: 11:30pm, 6 Nov 2019

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With the near-term risk of a further escalation in the US-China trade war receding, it is a good time to check the pulse of the Chinese economy and reflect on Beijing’s recent policy operations.

The third-quarter GDP data, while in line with our expectation, showed that economic growth has slid to its lowest level in almost three decades.

Year-on-year growth has fallen by 0.2 percentage points per quarter this year, from 6.4 per cent in the first quarter to 6.2 per cent in the second quarter and to 6 per cent in the most recent quarter.

This momentum is likely to continue in the fourth quarter, taking growth to 5.8 per cent, due to the ongoing direct and indirect fallout from the trade conflict.

Unless there is a rollback of existing tariffs, Beijing’s tepid stimulus policy is unlikely to be enough to prevent the economy from slowing further to below 6 per cent growth next year.

Zooming in on this key driver of weakness, the latest trade data shows that China’s exports to the US have continued to tumble. Total US-bound shipment fell by a whopping 22 per cent in September from a year earlier, driven predominately by items that are subject to extra levies.

Our estimate, based on US census data, shows that Chinese exports of tariffed goods plummeted by over 30 per cent, year-on-year, whereas those of non-tariffed products grew by close to 10 per cent.

The balance of the two clearly points to the damage of the trade war.

Besides the direct effects, the collateral damage of the trade war is also becoming visible. Our estimate shows that the secondary industry, which captures mostly industrial and manufacturing activities that are sensitive to trade, has accounted for most of the slowdown in GDP growth this year.

More worryingly, survey evidence shows that a growing number of multinational companies in China have already or are going to reallocate parts of their production out of the country due to tariff concerns.

Even though hard evidence of this supply-chain readjustment is still hard to come by, the risk of companies putting their money where their mouths are will rise as the trade war rages on.

Hence, getting a deal done quickly, and thus restoring some confidence in the economy, is key to mitigating the erosion of China’s long-term competitiveness.

In contrast to the embattled trade sector, activity in the domestic economy has held up. GDP growth in the services industry was steady at 7 per cent in the third quarter.

The household sector also remained resilient, with retail sales growth rebounding in September to a three-month high of 7.8 per cent, supported by a solid labour market and steady income growth.

Employees work at a Sany Heavy Industry manufacturing plant in Changsha, Hunan, on October 19. China’s secondary industry, which captures mostly industrial and manufacturing activities that are sensitive to trade, has accounted for most of the GDP growth slowdown this year. Photo: Reuters

Overall investment activity was tepid, although growth in infrastructure investment has continued to edge higher.

The recent easing on infrastructure financing via local government special bonds appears to have gained some traction, and this momentum should continue into 2020.

Overall, the latest macro data reveals a bifurcated economy. On the one hand, the trade manufacturing sectors, and those closely related to it, have continued to struggle as a result of the intensified trade war and slowing external demand.

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On the other hand, the domestic economy – in terms of services, consumption and the labour market – has held up better, thanks to increased policy accommodation.

If the upcoming phase-one deal between the US and China leads to future tariffs being suspended, it will obviously help to alleviate pressure in the embattled sectors and mitigate risks for the economy.

However, predicting the outcome of trade talks has been a futile task and, as a result, investors need to stay humble and recognise that the outlook remains murky.

A woman checks the price tag on a piece of clothing in a mall in Shenzhen, on November 1. The household sector has remained resilient, with retail sales growing 7.8 per cent in September, supported by a solid labour market and steady income growth. Photo: AP

For policymakers, there is little room for complacency. Beijing cannot turn a blind eye to the weakness in the secondary industry, which still accounts for more than 40 per cent of the economy and 30 per cent of employment.

Renewed producer price index deflation – at a three-year low of minus 1.2 per cent – suggests more policy support is needed to prevent a crash landing in the sector.

On the monetary side, expect a further cut of 5-10 basis points in the loan prime rate before the year end, along with another cut of 50 basis points to banks’ required reserve ratio.

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However, sustained progress in trade negotiations could see these cuts postponed to early 2020 until just before the Lunar New Year.

Fiscal policy will also be doing more heavy lifting, although future moves will be data dependent. Fiscal expenditure growth has already rebounded, while continued tax relief should also help put a floor under the economy’s slowing growth rate.

Beijing looks set to maintain its prudent policy setting, with an easing bias, in 2020. But unless there is a rollback of existing tariffs, this tepid stimulus is unlikely to be enough to prevent the economy from slowing further to below 6 per cent growth next year.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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