China growth is expected to slow on policy tightening

China’s growth is likely to slow going forward, despite the recent rebound,  as the authorities aim to cool the property market, reign in leverage in the shadow banking sector, and further cut capacity in old industries. We expect growth to slow from 6.9% in 2017 to 6.4% in 2018 and 6.1% in 2019. For more in depth insight, please see our recently published China Economic Insight 2018.

Total Credit Growth

(“Total Social Financing”, %, year on year)

China’s potential GDP growth is on a downward trend due to demographic headwinds (working age population peaked in 2014), and slowing productivity. Nevertheless, GDP growth edged higher to 6.9% in 2017 from 6.7% in 2016, marking the first acceleration in annual growth since 2010. The acceleration was driven by a turnaround in the contribution of net exports on the back of a strong recovery in the global economy and trade volumes. The pickup in net exports more than offset a continued slowdown in the domestic economy. Investment contributed 2.2 pps to growth in 2017, down from 2.8 pps the year before and consumption contributed 4.1 pps in 2017 from 4.3 pps the previous year, reflecting  a slowdown in auto sales, which grew 13.7% in 2016 on the back of a temporary sales tax cut for small cars which was gradually phased out in 2017.

However, the latest activity data suggests that the economy slowed towards the end of 2017 and in early 2018. Industrial production growth was down to 6.2% year on year in December 2017 from a peak of 7.6% in June 2017. Retail sales slowed to 9.6% year on year in December 2017 from a peak of 10.9% in September 2017. The official manufacturing PMI fell to 51.4 in April 2018, down from 52.4 in September 2017. Finally, credit growth slowed to 10.5% in April 2018 from a peak of 13.2% in July 2017.

Going forward, growth is expected to slow further as the authorities focus policy on improving the “quality” and “sustainability” of the economy. This suggests that the authorities will address imbalances in the economy such as elevated property prices,  rising financial risks in the shadow banking sector, and a still-high share of investment in the economy, all of which imply slower growth. Our forecast sees GDP growth slowing on the back of policy tightening measures designed to address imbalances in the economy.

First, the property market should continue to cool due to tighter macro-prudential regulations that began to be implemented in the third quarter of 2016. Examples include tighter down-payment requirements, home purchase restrictions, higher mortgage rates and financing restrictions for property developers. These measures have already slowed property price growth and investment in the property sector.

Second, the authorities are expected to tighten oversight of the shadow banking system in the face of rising leverage in the economy, and to raise the cost of funding for the financial system as a whole, leading to a continued slowdown in credit growth.

Third, fiscal policy should turn marginally restrictive as the size of the “augmented” fiscal deficit declines from an estimated 12.6% of GDP in 2017 to 12.1% in 2018.

Finally, growth in investment should continue to slow, as has been the case over the last several years, on the back of continued reduction in excess capacity in old industries such as steel, coal, and plastic industries, although this impact should be partially offset in 2018 by private investment in “new economy” sectors such as machinery, electronics and IT on the back of robust export demand.

Overall, we expect China’s growth to slow to 6.4% in 2018 and 6.1% in 2019 as these tightening measures are implemented by the authorities. To reverse the long-term downward trend, an increase in growth in the working age population or productivity is required. Recent reports that all birth controls could be removed later this year would help with the long-term growth of the working age population. Regarding productivity, as China’s economy has increased in size, it has become harder for the centrally controlled government to allocate resources efficiently. It may require the state to relax its tight grip on the economy to enable an improvement in productivity growth in the future.

 

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