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China outlook: steadier, slower, surer

5 minute read

12 November 2019

By Henk Potts, Senior Investment Strategist

Will fiscal spending and easier monetary policy be sufficient to support the economy in 2020, as Chinese growth is buffeted by the US trade war?

China is an essential driver of global growth. Its share of worldwide output has risen to 16% in 2018 from 1.9% in 1992, representing a dramatic change in global dynamics.

China is projected to surpass the US as the world’s largest economy between 2030 and 2050. So, the country’s future growth profile has widespread implications for the global economy (see chart).

China increasingly influences global growth

Domestic consumption vital

China is an economy in transition. We have previously characterised the Chinese economy as an arena for state investment, a manufacturing powerhouse, but increasingly China should be considered a domestic consumption-led economy.

The National Bureau of Statistics of China estimates that domestic consumption accounts for 42% of economic activity, up from 15% in 1991. The country is already the largest market for cars, computers and smartphones. Consultancy firm Bain estimates that the Chinese consumer made 33% of luxury purchases in 2018. Domestic consumption will continue to be supported by a growing middle class, higher wages, and longer life expectancy.

Faster urbanisation will also be a key driver of domestic consumption. The share of China’s population living in urban areas has more than tripled since the 1960s, rising from 18% in 1960 to 56% in 2015. Urban households are estimated to spend twice as much as their rural counterparts, according to a paper published by Federal Reserve Bank of Kansas City.

Growth drags

Trade wars have clearly infringed on China’s growth prospects. We estimate that the imposition of tariffs on $360bn worth of exports to the US has reduced Chinese growth by the equivalent of 30-50 basis points per annum. The recent detente has provided some respite, but a re-escalation would encourage us to further downgrade China’s growth outlook.

A debt deleveraging programme also weighs on China’s immediate growth potential. Domestic capital markets are relatively undeveloped; so companies are reliant on indirect financing. Credit growth has risen rapidly in recent years, pushing leverage to all-time highs and leading to concerns about the size of the shadow banking sector. Authorities have been aware of the issue and are reining in borrowing at state-owned enterprises, tightening credit conditions for property developers and introducing financial market reform.

Balancing act

In 2020 we think that Chinese authorities will attempt to maintain a fine balancing act, as they look to mitigate the risks of the trade war, reduce leverage, while promoting a steady, but slower growth profile.

We expect policymakers to continue to use fiscal policy measures (tax cuts and infrastructure investment) to support the economy. Further, monetary easing is anticipated in 2020, but is likely to be moderated by fears of exacerbating a housing bubble, leverage levels and inflation constraints. So anticipated policy response is likely to be restrained compared to previous bouts of economic weakness.

Outlook

We expect Chinese growth of 5.5% in 2020, representing a significant reduction from the estimated 6% in 2019 and 6.6% achieved in 2018.

For the next five-year plan, due to start in 2021, economists project growth of 5-5.5%. These forecasts represent a substantial slowdown from the 10% growth rate of just a few years ago. However, China is a much larger, more mature economy and is still generating an economy the size of Australia each year.

China is a much larger, more mature economy and is still generating an economy the size of Australia each year.

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