As the new year approaches, it is a time to reflect. 2019 has been a turbulent year for China for many reasons, and this article aims to summarise some of the major economic changes that have happened. We then look to the years ahead. It could be a bumpy ride.
2019 has been characterised by a weakening economic environment for China. Our China Momentum Indicator (CMI 2.0), an alternative gauge of economic activity in the country started the year at 5.1%, and reported a continuous downward spiral, with the latest figure posting 4.1%. The official GDP measure also slowed, with the Q3 figure hitting the lower bound of the PBOC target for growth at 6%.
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One of the overriding themes for 2019, and one dominating the media is trade tensions between the US and China. The tensions began after Donald Trump won the US presidential election in 2016, reaching boiling point in 2019. The US claims that China operates unfair trading practices and intellectual property theft and wants to force China to operate on a level playing field. The deteriorating relationship between the two countries has had damaging effects on China’s economy, especially the manufacturing sector, which has experienced periods of contraction according to PMI data, since the tensions began. Despite the implementation of multiple rounds of tariffs throughout 2019, we are ending the year on a more optimistic note. Both sides are engaged in dialogue, with the hope that this will translate to a deal. There are stumbling blocks to this, such as the current political instability in Hong Kong, which threatens to derail any progress made. Our central scenario is one of enduring tensions, regardless of any compromises reached.
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Despite these ongoing US–Sino tensions, the slowdown in China’s economic activity is greater than can be attributed to the drag from trade tensions alone. Indeed, as we explained to clients in our latest Global Economic and Markets Outlook, we find that the deteriorating global trade environment accounts for around two-thirds of the slowdown in our China Momentum Indicator since end 2017. The rest can be accounted for by domestic structural issues, such as poor allocative decisions, excess capacity, and the rising incidence of non-performing loans. But rather than transition the economy away from this old-style growth model, China has doubled down — cutting lending rates and allowing local governments to issue special bonds as capital for major investment projects, all the while, propping up inefficient and loss-making industries. This is illustrated in the second chart below, which reports that in Qinghai around 40% of all industrial enterprises are now loss making.
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So, what is next for China? In order to shore up growth in a sustainable manner China needs to rebalance its economy away from the old growth engine of investment and manufacturing and focus on more consumer-led growth. 2019 has shown that domestic consumption in China has failed to offset the slowdown in private investment, an essential mechanism for efficient rebalancing. If the PBOC were to respond by implementing further fiscal transfers to promote a better distribution of wealth, this might boost consumption. We will have to wait and see whether it is a ‘New Year, New China’, but we at Fathom are forecasting more of the same. As the economic outlook weakens further, China will find it difficult to resist falling back on those old, tried-and-tested methods to push up short-term growth. We expect this to be to the detriment of a sustainable long-run growth path.
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