The 2020 outlook for China’s economy remains gloomy, but there is one bright spot

The Chinese economy faces a tough road ahead, since breakthroughs in trade talks are unlikely in a US election year. A silver lining is that the rebalancing of the economy towards consumption has helped to support the labour market

Aidan Yao

Published: 3:00am, 5 Dec, 2019

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After a moderate slowdown in 2018, China’s annual economic growth is likely to fall to 6.1 per cent in 2019, the sharpest drop in seven years. The macro picture for the year ahead remains precarious. The raging trade war and cautious policy easing are likely to compound the slowdown, taking annual growth to 5.8 per cent in 2020.

This forecast is made with the following three key considerations: the economy’s natural growth, the trade war prospects and the degree of policy easing by Beijing.

China’s natural growth is likely to be slowed further by both structural trends and cyclical components. Structurally speaking, an ageing population and the transition to a less capital-intensive growth model are exerting a downward pull on growth.

In addition, our economic cycle indicator shows a persistent pattern of cycles spanning about 3½ years. If this pattern holds, the current cycle that started in mid-2016 could approach an end in late 2019, giving way to a new cycle in 2020.

On top of the slowdown in natural growth, the economy will probably continue to endure shocks. The trade war has been a major factor behind weakened exports and manufacturing over the past year and can be expected to extend its macro impact into the year ahead.

Fortunately, recent progress in trade talks has brought the United States and China closer to an interim deal, which – if signed – should halt further tariff increases.

However, the bar is higher for an actual rollback of trade tariffs, given the significant gulf in positions on issues such as technology transfer, intellectual property protection and China’s industrial policy.

The road ahead, therefore, is long and treacherous. US President Donald Trump would probably want to keep existing tariffs in place to force concessions over thorny issues from China.

Moreover, given that major breakthroughs in trade negotiations are unlikely in a US election year, an extended truce that preserves the status quo in levies is the most likely outcome. That said, we estimate that the lingering impact of the 2019 tariffs will lower GDP growth by 0.2 to 0.3 percentage point in 2020.

The escalation of the trade war with Washington has prompted Beijing to step up policy easing. However, the easing has so far been more restrained than in past cycles, for two reasons.

The first is the discrepancy between the intention and scope of certain policy tools. On the monetary side, the People’s Bank of China has plenty of room to cut interest rates and banks’ reserve requirement ratios.

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But the actual policy easing has been timid, due to Beijing’s desire to avoid worsening the structural and cyclical issues, which could destabilise the financial system and hamper the trade negotiations.

Those issues include high debt levels, food price inflation, a housing market bubble and excessive depreciation of the yuan. Also, besides an overall lack of liquidity, there is concern about the ineffective transmission of cheap credit to the private sector. Structural defects cannot be fixed by simply cutting interest rates or reserve requirement ratios.

While the authorities have more leverage than willingness to ease monetary policy, they have the opposite problem on the fiscal side. The aggressive tax cuts and fee reductions of the past two years suggest Beijing is keen to use fiscal policy as its primary tool.

But with the budget deficit ratio approaching 3 per cent and off-balance-sheet financing constrained by lower land sales and tightened local government debt, the scope for further stimulus is limited.

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The other reason for Beijing’s policy restraint may be the resilience of the labour market. While official labour market data has somewhat moderated, it is far from alarming. This is partly because more jobs have been created in the consumption and services sectors as a result of China’s economic rebalancing than in trade and manufacturing.

In other words, the reorientation of the economy towards domestic consumption is insulating the labour market against external shocks.

Overall, we think Beijing can afford to maintain a prudent policy so long as the labour market stays resilient. We estimate that monetary and fiscal boosts will add 0.3 percentage point to growth in 2020. However, it won’t be enough to fully offset macro headwinds and economic growth might still slow to 5.8 per cent.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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