Source: Euromonitor International
Baseline outlook: Smooth slowdown continuing.
China’s economy is expected to slow down from 6.9% growth in 2017 to 6.2-6.8% growth in 2018 and 5.9-6.7% growth in 2019. Subsequently, annual growth is expected to decline smoothly towards 4.5-5.5% over 2023-2027.
The economy expanded by 6.8% year-on-year in the first quarter of 2018, slightly beating expectations. Domestic demand increased by 7-7.5% year-on-year. In contrast, net exports declined in Q1 (mainly due to a fast rise in imports) and China reported its first current account deficit in almost 17 years in Q1 2018.
Secondary sector (mostly manufacturing and construction) growth was 6.3% year-on-year, while tertiary sector (mostly services) was 7.5%. Industrial production growth was 6.8% year-on-year, while services output increased by 8.1% year-on-year, accounting for 60% of GDP growth.
The Q1 GDP statistics highlight the ongoing transition to a more consumption and services oriented economy, though there is still a lot of room for the share of consumption in GDP to increase to that of other middle-income countries. They also highlight the much greater reliance on domestic demand in China’s economy compared to 10 years ago.
Source: Euromonitor International
At China’s National People’s Congress March meeting, the 2-term limit on presidential terms was dropped, allowing Xi Jinping to continue on as president indefinitely beyond 2022. In the same meeting, Xi was unanimously appointed to a second term as President. These moves consolidate Xi as the most powerful Chinese leader since Deng Xiaoping. On a positive note, if Xi continues his current policies, the extra continuity may provide more room for bolder structural reforms and stronger economic rebalancing, due to lower risks of opposition from special interest groups. However, there will be less of a counterweight to Xi’s decisions if he makes policy mistakes. Also, a greater centralisation of power could complicate succession plans, creating more uncertainty about the continuation of the Communist Party’s political dominance after Xi is gone.
Estimated baseline forecast probability: 20-30% over a 1-year horizon.
Forecast Risks
Most likely pessimistic scenario: an abrupt decline in house prices, lower private sector confidence, lower than expected wage growth and tightening credit markets cause GDP growth to drop to 5.6-6.2% in 2018 and to 4.4-5.2% in 2019.
Source: Euromonitor International
Estimated scenario probability: 15-25% over a 1-year horizon.
Most likely optimistic scenario: the government decides to delay some of the costs of economic restructuring via more aggressive fiscal stimulus and reversing its current tightening of access to credit for local governments (LGs) and State Owned Enterprises (SOEs). It also relaxes borrowing requirements in real estate markets, stimulating construction. GDP growth rises to 6.7-7.3% in 2018 and 7.0-7.8% in 2019. However, this scenario comes with higher medium-term risks of a more severe future downturn or hard landing.
Source: Euromonitor International
Estimated scenario probability: 15-25% over a 1-year horizon.
Over March and April, the US imposed 25% tariffs on USD50 billion of Chinese imports in aerospace, ICT and machinery, in addition to earlier tariffs on steel and aluminium imports. Further tariffs on up to USD100 billion of Chinese imports are possible in May or June. The tariffs announced so far only affect 3% of China’s exports or 0.6% of China’s GDP. Therefore, they should have quite a small macroeconomic impact, reducing the size of China’s economy by 0-0.2% over 2018-2020.
An all-out trade war is unlikely at this stage since China has other means to deter further US tariffs than direct retaliation, such as pressure on key US multinationals operating in China. However, the risk of a US-China trade war has increased to a 10-20% probability over a 1-year horizon and a 15-35% probability over a 2-year horizon. While China’s reliance on trade for its growth is declining, exports to the US still account for around 4% of GDP. Our trade war scenario assumes a 15-25 percentage points increase in bilateral China-US tariffs. It would reduce China’s annual GDP growth rate by 0.3-0.6 percentage points over 2018-2020.
Despite the all the recent headlines about trade wars, China’s economy is more vulnerable to other more significant risks, such as a global financial markets correction and loss of private sector confidence, leading to a downturn. A global downturn would lower China’s annual GDP growth rate over 2018-2020 by 1-2.5 percentage points. We assign this scenario an 8-13% probability over a 1-year horizon and a 15-25% probability over a 2-year horizon.
China’s debt levels have stabilised recently relative to GDP, and the government has prioritised controlling financial system risks. Nevertheless, we still assign a China hard landing scenario a 6-11% probability over a 1-year horizon and an 11-21% probability over a 2-year horizon. In this scenario, a banking crisis combined with unexpected problems in the rebalancing process would cause an annual decline in China’s GDP growth rate of 1.5-3 percentage points over 2018-2020.
Aggregate demand: Role of consumption in economic growth increasing
Consumption accounted for almost 80% of GDP growth in Q1 2018, while fixed investment accounted for 31.3% of GDP growth. Consumption growth was supported by solid real disposable income per capita growth of 6.6% year-on-year, though this reflects weaker 5.7% growth in urban areas combined with faster 6.8% growth in rural areas. Consumer confidence also remains extremely high, though it is no longer increasing relative to the end of 2017.
Real consumer spending has increased significantly faster than GDP growth over 2012-2017, at an annual rate of 7.8%. Growth is expected to slow down to 6.2-7.2% annually over 2018-2022, but it will continue to exceed overall economic growth. The shift towards consumption by middle and high-income households, with annual household income above USD15000, will continue. Real spending of middle-income households is expected to increase by 8.5-9.5% annually while spending growth in the top segment (with annual household income above USD45000) is expected to reach 11-13% annually. From a business perspective, while China’s economy overall is slowing down towards growth rates of 4.5-6.5% over the next 10 years, the best segments for consumer goods and service firms are likely to continue growing at rates similar to those seen in the 2000s.
Financial conditions: Debt levels remain high, but they are stabilising.
The Chinese Government continues to show a stronger commitment to controlling local government and SOE debt, with a recent ban on further lending by state banks to local governments. In recent statements, President Xi has directly put pressure on state-owned enterprises and local governments to reduce their debt levels faster. The government’s efforts have contributed to a decline in Yuan loans growth to 12.8% year-on-year during the last 3 months.
There are still concerns about excessive credit flowing to inefficient firms and projects. However, the recent deceleration in SOE fixed investment to a 6.5% year-on-year growth (relative to 8.4% year-on-year growth in private fixed investment) suggests the government’s efforts have started reducing the misallocation of credit to the state sector.
Bank for International Settlements (BIS) data shows China’s non-financial sector debt to GDP has increased slightly to 256.8% in Q3 2017, with corporate debt to GDP declining. Debt to GDP is expected to stabilise at 255-265% by the end of 2018. Household debt to income levels is expected to continue rising, though remaining low by international standards.
In its recent report, the BIS still classifies China as having a high risk of a banking crisis. But the BIS credit to GDP gap measure for China (credit to GDP relative to its long-term trend) has declined, signalling lower financial system risks.
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