What does a potential China growth scare portend?
24 April 2019 | Markets and economy
Commentary by Qian Wang, senior economist at Vanguard in the United States.
With U.S.-China trade talks in the limelight, investors have been paying close attention to economic developments in China. Amid signs of progress, President Trump last weekend extended a March 1 deadline for increasing U.S. tariffs on $200 billion of Chinese goods to 25% from 10%.
2019 forecast: Bearish first half, more stable second
Economic implications of the two countries' trade war have become increasingly evident, with China's GDP slowing to 6.4% in the fourth quarter of 2018—its third consecutive quarterly decline.
Chinese policymakers promptly responded with a series of stimulus measures intended to protect short-term economic stability. These measures will take time to work through the economy and may not be as effective as in previous slowdowns, given the elevated leverage in the economy and structural differences in the drivers of this slowdown.
Vanguard expects China's GDP growth to be a bit slower than the consensus estimate for the first half of 2019 but to average about 6.1% for the full year; for 2018, it was 6.6%.
China GDP growth
Forecast below consensus for first half of 2019
Sources: Thomson Reuters Datastream, CEIC Data, Bloomberg, and the National Bureau of Statistics of China.
China's growth derives from two economies:
- An old economy based on state-owned enterprises, low-end and heavy manufacturing industries such as textile, coal, steel, and concrete production, as well as real estate.
- A new consumer-driven economy led by private enterprises and reflected by domestic consumption, high-skill manufacturing, and service industries.
Our bottom-up growth model based on micro-industry indicators shows that weakness in the new economy is primarily driving the current slowdown.
Stimulus measures that proved effective in 2015 and during other old-economy slowdowns—measures such as overall liquidity and credit easing, as well as administrative orders for state-owned enterprises to increase investment and production—wouldn't likely be as effective or efficient in stimulating the new economy.
What's required instead are measures that boost domestic sentiment and incentivize private enterprise. We believe the recent stimulus measures taken by Chinese policymakers will deliver. Hence, we view a China hard landing in 2019 as unlikely.
Implications for the global economy and markets
China has proven its ability to roil the global economy and financial markets. Memories are still fresh of 2015, when Chinese equities fell more than 40% in just over two months and the country lost $1 trillion in foreign currency reserves.
The relatively good news this time, however, is that the spillover effects through financial channels will be less severe because of capital controls implemented in recent years. These controls reduce the risk of large-scale capital outflows and heightened currency depreciation pressure, such as those witnessed in 2015–2016, and thus help head off a surge in global risk aversion.
In terms of economic growth, emerging-market countries will be hit hardest by the anticipated slowdown in China. The impacts are expected to be in the range of –0.10% to –0.20% for the United States but as high as –0.49% to –0.64% in Asian and Latin American emerging markets. Japan and Europe will also feel the sting from export-related weakness.
Will growth scare spur a U.S.-China trade deal?
Despite policymakers' efforts to stabilize domestic growth, the trade conflict with the United States remains a wild card.
In the short term, the pause in tariff escalations may persist while negotiations on long-term structural issues continue. A partial deal may result that could involve a significant rise in imports from the United States, easing restrictions for foreign firms and creating more equal tariff alignment. These developments would likely boost market sentiment and reduce the probability of a China growth scare this year.
However, caution is warranted over a longer time horizon. The scope of U.S.-China disagreements extends beyond trade to such areas as investment, technology, intellectual property rights, market access, and industry policy. Although China has expressed intentions to make fundamental structural reforms in these areas down the road, it will be challenging to meet the pace and magnitude of changes desired by the U.S. administration. Therefore, the U.S. may use the pressure of further escalation to pursue a later deal on long-term issues. Chinese policymakers will remain on alert and be ready to deliver additional stimulus measures should the situation sour.
I'd like to thank Adam Schickling, CFA, junior economist in Vanguard Investment Strategy Group, for his assistance with this post.
The views expressed in this material are based on the author's assessment as of the first publication date (March 2019), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The authors may not necessarily update or supplement their views and opinions whether as a result of new information, changing circumstances, future events or otherwise. Any "forward-looking" information contained in this material should be construed as general investment or market information and no representation is being made that any investor will, or is likely to achieve, returns similar to those mentioned in this material or anticipated in this material.
This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation.
While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.
Information, figures and charts are summarized for illustrative purposes only and are subject to change without notice.
This material does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.
In this material, references to "Vanguard" are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.