Looking back at 2018, it’s been dog days for the Chinese economy as policymakers nervously toe the line between maintaining economic growth and containing threatening structural imbalances. Let’s take a moment to reflect on the massive headwinds that shook the pillars of the Chinese economy as we head into the year of the pig.
Obstruction One: Deleveraging takes a bite out of China’s GDP
We first felt the winds of change when the central government made deleveraging one of its top reform priorities. The nation’s debt mountain has risen to among the highest in world as a percentage of GDP, with pessimists warning that the $34 trillion public and private debt bomb could bring the global economy into an economic winter.
With 67% of global debt belonging to the Mainland, policymakers took hardline efforts to deleverage.
Deleveraging put substantial pressures on financing the real economy. M2 money supply growth slowed to nearly 8% in 2018, the lowest level in history, due to the PBOC‘s deleveraging campaign. The unsustainable methods to lower the debt ceiling, dragged the country’s economic growth down to record lows in over a decade. The curb in money flows particularly made the real estate sector a prime target.
The deleveraging drive made lenders cautious about extending credit, making it difficult for developers to raise funds and repay debts. It also forced smaller property firms to be pushed out of the market.
Stricter measures alerted banks to reassess their outstanding loans, causing the non-performing loans of Chinese commercial banks’ to decelerate but only to rebound again in 2018. Non-performing loans rose from USD$$26.6 billion to hit USD$29.1 billion by June 2018, the biggest quarterly increase going back more than a decade, signalling that regulators have started backpedalling on the deleveraging campaign.
Faced with the adverse effects the deleveraging strategy has had on domestic growth, China saw that its deleveraging policy needed an adjustment. As highlighted in a previous company report, policymakers’ softened their attitudes towards deleveraging, countering the impacts with the PBOC cutting the required reserve ratio by 50bps to fight against the slowing economy. To encourage greater market liquidity, the PBOC launched a series of new tools including Targeted Medium-Term Lending Facility (TMLF) and Central Bank Bills Swap (CBS).
Source: NBS
Obstruction Two: Social Security Reform or Risk to GDP?
Boosting consumption in an already wavering domestic sentiment is no easy task. China’s GDP quarterly growth has already slidden three times in a row since 1Q18. While China experienced a growth of 6.8% in 2018, it’s still the slowest pace since 1990. Announced in July of 2018, China was preparing to introduce a new system of collecting social insurance levies, consolidating the power to collect funds solely to its taxation departments. This new system which was intended to take into effect in early 2019, hoped to mitigate loopholes of evasion and streamline collections more transparently and efficiently.
This policy introduction however, shone a spotlight on the bad practices of a majority of Chinese companies. A third-party report has however revealed that only 24.1% of Chinese firms actually comply with the payment rules of social security. It had also revealed that 75.9% of companies cooked the books in regards to these payments, declaring its contributions based on minimal salaries of their employees in order to fork out less. Social insurance payments exceeded payroll tax collections by US$68 billion in 2017, which ultimately results in the loss of benefits workers can claim.
Source: NBS
With the increased burden of potential social security reform, corporates could lose profits of approximately 2.5%, threatening smaller businesses and job security. Following the announcement in July, both new employed population growth and reemployed population growth declined. Looking specifically at the manufacturing industry, the average employment rate, especially the hiring rates in medium and small sized enterprises, also took a turn for the worst, signalling the early preparation employers were taking to mitigate their insurance burden.
This move by the government while well intended, could go against its efforts to encourage growth in consumption. With employer jitters being felt in the market, local governments in January of this year decided to delay its hopes for reform in order to alleviate the financial stress on businesses.
If we look purely at consumer spending in 2018, consumption still contributed over 76% to total GDP, 10 pts higher than 2015’s number. China’s efforts to ramp up domestic consumption to drive the economy did pay off to an extent, with consumption growth rising faster than overall economic growth.
Obstruction three: Trade War, the tipping point of GDP scale
China has long relied on exports to fuel economic growth but as the country shifts towards growth led by domestic consumption, exports have played a less dominant role. To meet demands, China saw relatively strong import growth in 2018, with the US still being the largest trading partner in imports to the Mainland.
Products that China imports span from airplanes, cars industrial machines to commodities like soybeans, crude oil and plastic materials. The US, on the other hand, imports goods like LEDs, Furniture, Telephone sets and Toys.
But all these products in 2018 came to a point of serious contention after looming trade war talks came into full effect in July with the first USD$34 billion slap of Chinese and US tariffs. Since then, the two superpowers have retaliated with rounds of tit for tat tariffs making it the final obstruction to China’s economic growth.
China’s imports outweighed the exports, signaling potential pains if the US and the second-largest economy do not come to a trade agreement.
But if we look at 2018 chronologically, despite the initiation of a trade war in the last year of March, China’s exports to the US held up relatively well, implying that China’s competitive product pricing was still attractive enough in the short term as compared to finding a replacement. Chinese exports to the US rose by 12.9% from a year ago to US$46.2 billion, as exporters rushed to fill orders before additional tariffs were implemented. Net exports rose to a record total high of US$323.33 billion in 2018. However, this is projected to fade early this year.
Chinese Technology Companies’ investments in the U.S from 2015-2018
But if we look specifically at the tech sector, which takes up 32.9% of the nation’s GDP, and accounts for 22% of the nation’s employment in 2017, China has a lot at stake. In a race between the US and China for technological dominance, President Trump, the Tariff Man, has hit China where it hurts, putting into effect tariffs imposed under Section 301 of the 1974 Trade Act which addressed technology-related issues like forced technology transfer, discriminatory investment restrictions, predatory acquisitions, cyberattacks and espionage.
Chinese Technology Companies’ investments in the U.S from 2015-2018
When we take a closer look into Chinese technology companies and its investments into U.S companies across all sectors, according to our analysis, from 2015 to 2018, investments have dropped by almost half. If tariffs continue persisting, or worse surmounting, it will encourage firms in supply chains to shift production elsewhere.
In a move to slow-down China’s technological growth, in August 2018, Donald Trump signed off on the Export Control Reform Act of 2018 which puts further controls on U.S. exports of “emerging and foundational technologies.” This will make it tougher for companies in Chinese supply chains to source high-value added U.S. technology and can also be used to ban sales of components and technologies to China. In December 2018, China’s total imports fell to US$164.19 billion, a drop of 10% from last month and down 7.6% a year earlier, signalling China’s economic slowdown and the weakening of Chinese domestic demand.
“We believe that sturdy consumption growth will continue and it will be the key pillar to the GDP expansion given the tightening labor market.”
As we usher in the year of the pig, the trade dispute between the US and China will continue to persist in 2019.
Risks of an economic slowdown have become worse-than-expected and this is proven by a rare joint press conference from the 3 key policy-setting bureaus in China. The MoF, PBOC and NDRC held a conference to comfort market investors by announcing a series of expansionary policies in the works. In general, as we look into an economic outlook filled with dark clouds, corporate capital expenditure plans will pause or slow down ahead, but it will vary from sector to sector. We believe that sturdy consumption growth will continue and it will be the key pillar to the GDP expansion given the tightening labor market.
With less pressure from investors’ with high expectations on economic growth, China will take this chance to accelerate structural reforms that they’ve been hesitating to launch for years. Recently, China quickened the pace when it came to opening the market to foreign countries, such as shareholding restrictions on foreign investors. We expect to see more foreign interest coming in in 2019 to regain market confidence in China.
For more, download a free report that zooms in further on China’s economic pulse in 2018. Look into sector contributions to GDP. Find out if China’s deleveraging policies are at its end. Discover what exactly Chinese consumers are spending on and its impacts on retail and online sales. And finally, for insights into investment opportunities, discover how sectors affected fixed asset investments in the year of the dog. Click below to find out more!