China at a turning point?
10 July 2018
Though investors pay more attention to US policy developments, it pays to follow Chinese developments at least as closely. In early 2009, China’s enormous stimulus signalled the beginning of a bull run in commodity prices and EM growth that would last until the middle of 2011. At the end of 2015, it was again Chinese stimulus that helped kick off a global industrial upswing over the subsequent two years. And that upswing is now beginning to peter out, or at least become less synchronised, in part due to the steps the Chinese authorities have been taking to restrict the availability of credit, especially from the shadow sector. This has resulted in a significant slowdown in aggregate credit and money growth over the past year (see Chart 10). Up until the past couple of months, PBOC policy had been mostly focused on preventing this tightening in credit availability from causing a sharp increase in market lending rates without acting against the broader objective to make the financial system safer. This strategy has been relatively sound, as the composition of our China Activity Indicator shows that tighter financial conditions have mostly weighed on the industrial sector, as services activity has remained firm throughout. Indeed, this suggests a greater resilience of the economy to credit tightening than in previous episodes.
More recently, however, the tone of PBOC communications has become more dovish, more easing steps have been taken, both in reaction to signs that previous credit measures were having too severe an impact on parts of the economy, but also the escalation of trade tensions with the US. Further easing measures are likely over the coming months, providing scope for aggregate credit and money growth to pick up from their recent lows, albeit not on the scale that was observed through 2016. Though the Renminbi could also depreciate further, especially if the USD continues to appreciate, the PBOC will continue to manage any adjustment to discourage speculation and capital outflows. It is not surprising that the recent stabilisation of the currency has coincided with a modest recovery in A-shares, as well as broader global equities. At the component level, the policy and credit easing underway should provide a boost to growth in the housing market and fixed asset investing, in turn lifting our industrial activity indicator.
One risk to this view is trade policy, where any further follow-through on tariff increases, as well as retaliatory responses, would represent a headwind to growth, particularly in manufacturing. Last week the Trump administration announced that it would impose a 25% levy on imports from China worth around $34 billion across 818 product lines. Further announcements are likely over the coming weeks. The Chinse response has been low-key so far, but authorities are unlikely to stand by idly; however, they are likely to take a more targeted and less growth-unfriendly approach than the US. In fact, because much of the value-add embedded in Chinese exports to the US originates from other Asian economies such as Malaysia, South Korea and Thailand, and those economies are much more open to trade than China is, the largest impact of US actions will be felt elsewhere in the region (see Chart 11). In a world of integrated supply chains, tariffs are a blunt tool with which to pursue trade policy objectives.