The ongoing (and intensifying) trade spat with the US has already begun to dent sentiment and crimp
activity in the Chinese economy
• China’s manufacturing sector is in unenviable shape: China’s official PMI figure fell to the 50.0 no expansion-no contraction level in November from 50.2 in Oct 18, snapping a 28-month growth streak. Further deterioration is likely, with new orders easing further to 50.4 from 50.8 in Oct 18. External demand provided little relief with new export orders contracting for the sixth-consecutive month, at 47.0. Industrial production grew 5.4% y/y in Nov 18, down from 5.9% in Oct 18 and might possibly dip further as the frontloading of Chinese goods comes to an end. Nov 18’s reading was the weakest in 10 years. Automotive production is an exceptionally weak spot.
• Squeezed industrial profits: Profits at China’s industrial firms slumped for the sixth consecutive month, rising just 3.6% y/y in Oct 18 and down from a 4.1% y/y gain in Sep 18. Profits at stateowned industrial enterprises gained 20.6% y/y in Oct 18, down from +23.3% y/y in Sep 18, whilst profits at private industrial enterprises rose just 9.3% y/y in Oct 18, unchanged from Sep 18.
- Fixed asset investment (FAI) growth emerging from a trough: FAI accelerated for the second straight month in Nov 18, rising 5.9% y/y year-to-date, up from 5.7% in Jan-Oct 18 and marking a nascent turnaround since the nadir in August. Private sector FAI stayed solid, up 8.7% y/y in JanNov 18 (8.8% in Jan-Oct period), though public sector FAI stayed relatively weak despite a small improvement to 2.3% y/y ytd in Nov 18 (1.8% in Jan-Oct 18). Should this turnaround be sustained, this could support to some extent economic growth in 2019 and brighten the outlook somewhat.
- No reprieve from external demand: Even though the bilateral trade surplus with the US widened further, trade flows were generally a disappointment in Nov 18. China’s exports increased 5.4% y/y in Nov 18, a massive deceleration from 15.6% in Oct 18. Import growth came in at its weakest pace in two years, expanding a mere 3.0% y/y in November, down from 21.4% in October. Consequently, the trade balance rose to USD44.8bn in Nov 18, up from USD34.0bn in Oct 18 in large part due to the collapse in import growth.
- Downbeat portents for consumption: Retail sales registered a historic low pace of growth at 8.1% y/y in Nov 18, down from 8.6% in Oct 18. The pessimism among Chinese consumers appears to be the most pervasive in the automotive sector. The dark cloud that is the uncertainty stemming from the US-China trade conflict has weighed heavily on consumer sentiment.
- Monetary aggregates rallied slightly: The M2 money supply increased 8.0% y/y in Nov 18, unchanged from Oct 18. New Yuan loans rose to RMB1.25tr in Nov 18, rallying from RMB697bn notched in Oct 18. Total social financing – a broad measure of credit in the economy – rose to RMB1.52tr in November, up from RMB728.8bn in October. This represented growth of 9.9% y/y in Nov 18, albeit down from 10.2% in the previous month. However, this annual growth in November was a record low.
- Quiescent inflation indicative of weakening demand: China’s headline CPI increased 2.2% y/y in Nov 18, down from 2.5% in Oct 18, dragged down by softening growth in food prices. This reading was the lowest in four months. Core CPI, which excludes food and energy, remained unchanged at 1.8% y/y in Nov 18. Year-to-date, CPI increased 2.1% y/y in November, comfortably below the 3% target. The producer price index (PPI) increased 2.7% y/y in Nov 18, down from 3.3% in Oct 18. The PPI has since decelerated for five consecutive months and is at
its slowest pace in two years.
Assessment (1): A litany of downside risks stalks the Chinese economy
First, the outlook for China’s all-important manufacturing sector remains negative given that new orders which is a forward-looking indicator of activity, has slid for four months in a row. An outright contraction in the sector cannot be ruled out after an end to the long spell of expansion: whatever little boost there was from tariff-induced front-loading of purchases has faded, as evinced by the flatlining in new export orders.
Second, falling factory-gate and commodity prices reflect sluggish demand and downbeat expectations of future economic conditions. In turn, waning industrial profits may translate into further weakness in investment demand; even as the authorities rush to implement the flurry of credit-easing measures seen in recent weeks, the government’s coterie of state-owned banks may quickly find itself pushing on a string. As such, the incipient signs of revival in fixed-asset investment (FAI) could prove to be short-lived.
In short, the burden has shifted to consumer spending – but here too, the headwinds appear to be strong. Finally, while external demand has held up thus far despite the trade spat, the apparent strength stems from the front-loading of exports before the tariffs came into full effect. The vigour in exports could begin to fade in early 2019. The silver lining is that modest price pressures accords monetary diktats with the wiggle room for further stimulus if required – which brings us to our next insight.
Assessment (2): Policy intervention may not be as effective as in the past
Worryingly, there are signs that the efficacy of policy tools has severely diminished due to the accumulated imbalances in the Chinese economy and unintended consequences of previous policy interventions.
Indeed, major credit measures largely remained flat in November despite official pronouncements of easing via credit and liquidity taps to support economic activity, while there was a long lag time in the pick-up of infrastructure investment (which only recovered in October) despite easing measures being undertaken months earlier.
In our view, two key structural weaknesses are to blame:
- First, there is diminished incentive for local government officials to implement policies formulated by the central government. While necessary, the harsh and unrelenting manner in which Xi’s anticorruption crusade was carried out has gummed up transmission mechanisms in policy. For example, local bureaucrats are reluctant to approve projects since there is no more upside (bribes) but, rather, only downside (accountability even long after the bureaucrat in question has moved to another position).
- Second, there is reduced incentive for private entrepreneurs to boost investment. Wariness of the state is rife in the private sector. There is a growing perception that it is too risky for a private business to grow too large, lest it come under the notice of a CCP leadership that is suspicious of alternative power centres emerging from such private business lobbies.
Moreover, the trade-offs involved in macroeconomic policy are now much more difficult to square with than before. One instance would be the conundrum between promoting stability through reforms and spurring growth via more stimuli:
- Should the authorities boost investment to support growth, this could lead to a worsening of the current account balance and possibly plunge it into a wider deficit.
- Should policymakers opt to ease credit via an easier monetary policy to support growth, efforts to deleverage and de-risk the financial system are likely to go into reverse, and have a direct depressing effect on the Yuan.