China Forecast Updates, Q1 2018
Baseline Outlook: Economy will slow down, but growth will be more balanced
Chinese GDP growth for 2017 was 6.9%, significantly better than the government’s initial target of “around 6.5%” growth. Ongoing strong public infrastructure investment, robust consumption growth and improving foreign demand were key factors supporting growth in 2017. In 2018-2019, business investment growth is likely to suffer further declines due to production capacity cuts and stricter pollution controls, while strong consumer spending growth will play a bigger economic role. GDP growth is forecast at 6.2-6.8% in 2018 and 5.9-6.7% in 2019.
For now, the government’s efforts to control credit growth appear to have had only a modest negative impact on economic activity. From a more long-term perspective, China’s labour force growth has been negative since 2015, making labour productivity raising structural reforms critical for sustained growth. GDP growth is expected to decline to 4.9-5.9% annually in 2020-2024.
In the December 2018 economic policy meeting, China’s leadership reaffirmed its commitment to raising the quality of economic development and extend its benefits to larger segments of the population. The final statement of the policy meeting says that “China's economy has transitioned from a phase of rapid growth to a stage of high-quality development”. Policymakers emphasised as key objectives for 2018-2020 ensuring financial system stability, reducing inequality and reducing pollution. The consolidation of President Xi Jinping’s position beyond 2022 increases the credibility of these statements, by giving the government more freedom to accept short-term lower growth in exchange for more long-term economic development gains such as better income distribution and a more consumer-driven economy.
Estimated baseline forecast probability: 20-30% over a 1-year horizon.
Forecast Risks
The latest debt to GDP ratio data from the Bank for International Settlements (BIS) suggests that China’s debt levels have stabilised. In combination with ongoing government efforts to curb riskier lending activities, this implies a reduction in the risks of a major banking crisis. We have accordingly reduced our Chinese hard landing scenario 1-year ahead probability to 4-14%, and our 2-year ahead probability to 8-26%. In such a scenario Chinese GDP growth would decline to 2.9-4.1% in 2018 and 1.5-3.1% in 2019.
The US imposed large tariffs on imported solar panels and washing machines in late January. In February, it imposed tariffs on Chinese iron pipes and it is contemplating slapping tariffs on Chinese steel imports. Our baseline forecast assumes the US will only impose limited trade tariffs on specific industries in 2018. The need for Chinese cooperation in containing North Korea should also dampen any strong trade restrictions. But trade war risks are still present. We currently assign our Trade war scenario a 1-year ahead probability of 4-9% and a 2-year ahead probability of 8-17%. In this scenario, Chinese GDP growth would decline to 4.8-6% in 2018 and 3.7-5.3% in 2019.
Downside risks mainly come from excessively fast credit tightening or real estate price declines. The current historically high level of consumer optimism may also be unsustainable. While debt burdens have started stabilising, they remain dangerously high, especially for business.
In our most likely pessimistic scenario, lower private sector confidence and tighter credit conditions reduce aggregate demand. GDP growth declines to 5.2-5.8% in 2018 and 4.8-5.6% in 2019. Estimated scenario probability: 15-25% over a 1-year horizon.
In the most likely optimistic scenario, private sector confidence increases further and the government continues with stronger than expected fiscal stimulus through state-owned enterprise (SOE) and infrastructure investment. As a result, GDP growth rises to 7-7.6% in 2018 and 6.8-7.6% in 2019. Estimated scenario probability: 15-25% over a 1-year horizon.
Economic Activity: Slow rebalancing continues
GDP growth in the fourth quarter of 2017 was 6.8% year-on-year, barely slowing down from the first half of 2017. Growth for the whole year was 6.9%, up from 6.7% in 2016. The pattern of relatively slow industrial growth and faster services growth continued in 2017. Industrial production growth was 6.6% in 2017, up from 6% in 2016. The services production index rose by 8.2% in 2017, up from 8.1% growth in 2016. The economic weight of consumption continued to rise, accounting for almost 60% of GDP growth in 2017. Net exports improved on the back of stronger global trade, raising GDP growth by 0.6 percentage points in 2017 (after reducing growth by 0.4 percentage points in 2016).
From a longer-term perspective, the share of investment in the economy has declined by four percentage points since its peak in 2011. However, it is still above its level in 2008, when China’s government embarked on a large investment driven stimulus programme to counter the global financial crisis. The share of consumption in spending has grown slightly, but it is still much lower than for other comparable countries at less than 40% of GDP. Consumption growth is expected to reach 7-7.6% in 2018 and 6.9-7.7% in 2019.
Financial sector liberalisation, economic rebalancing and still high domestic investment have caused a secular decline in the current account balance relative to GDP. The current account balance to GDP ratio is expected to continue falling moderately, staying within 0.5-1.5% in 2018-2022. While US president Trump continues to complain about China’s trade surplus with the US, it is becoming much harder to accuse China of currency or trade balance manipulation. China’s central bank has allowed more freedom to foreign currency markets to determine the RMB’s value, avoiding major interventions in recent months, with further RMB liberalisation expected in the next 2-5 years.
Private Sector Sentiment and Financial Conditions: Consumer confidence remains high, debt levels have stabilised
Business confidence has stayed moderately above-average. Meanwhile consumer confidence increased significantly during 2017, though it is below its October peak.
Chinese stock prices declined by almost 6% in February (as measured by the Shanghai stock market index), following contagion from falling US stock markets and rising global interest rates. China’s household and business spending are much less tied to the stock market than in the US or even the Eurozone. However, stock market turbulence could have a modest negative impact on growth.
Financial stability remains a top priority for China in 2018. The central bank will maintain a “prudent” monetary policy stance, tightening several interest rates by another 0.1-0.3 percentage points and introducing further bank reserves ratios increases. The government has announced new measures to curb the leverage of SOEs, including more debt for equity swaps, promoting mixed ownership and improving bankruptcy and reorganisation rules. Leverage of industrial firms has declined slightly in 2017. Stricter new regulations aimed at controlling shadow banking are forthcoming in March.
Housing markets have cooled down in the second half of 2017. Year-on-year house prices growth was 5.2% in December-November, significantly below the annual 2017 average growth of 8.9%. In addition to previous real estate borrowing restrictions, China is launching several measures to encourage stronger growth in real estate rental markets in order to control real estate price appreciation. These include zoning regulations setting more space for rental properties, and credit subsidies for rental unit projects.
Government efforts to control financial system risks appear to have contained China’s previous debt explosion. The non-financial sector debt to GDP ratio stabilised by mid-2017 at 255.9%, with a modest increase of a few percentage points likely in the second half of the year. Money supply year-on-year growth (measured by M2) has stayed in an 8-9% range in recent months, while loans growth (measured by total social financing) was 12.5-13.5% year-on-year, in comparison to nominal GDP growth of 11%. Bank capital ratios have also increased, though smaller banks remain vulnerable to a credit shock.
In our latest report extract, we provide you with an update on our latest macroeconomic forecasts for key economies and what these mean for our predictions for the global economy. Download Global Economic Forecasts: Q1 2018 to stay ahead of risks and opportunities as they emerge on a macroeconomic basis.