China’s today in a worse economic situation than in 2015

Chinese economy has been under the global spotlight since 2018, amid the confrontation with the US and the sluggishness in investment and consumption. When put into longer context, Chinese economy has already been decelerating for quite some time and, in particular, during 2015 and early 2016. This note attempts to review this last episode of deceleration and compare it with the current slowdown. Our key take-away is that the current situation is more difficult than that of 2015.

?  China’s current deceleration is faster. China’s deleveraging effort is a prelude to the economic slowdown, limiting the access to credit especially for private sector, thereby pushing down growth.

?  As for the composition, manufacturing sector is more severely affected and also more volatile. This is related to one of the key differences between today’s situation and that of 2015, namely a much more targeted reduction in external demand due to the US-China trade war.

?  The government’s countercyclical policy reaction, on both fiscal and monetary fronts, is more restrained. This might be due to increasingly conflicting objectives, namely growth, deleveraging, environmental protection and housing affordability.

?  The perception of risk seems to be higher now as indicated by a larger – and more broad-based – number of defaults.

? As for exchange rate, while the depreciation pressure has been stronger this time, market response has been milder and, thereby capital outflows have been more tamed. This might be due to stricter capital controls than it was the case in 2015.

? Because capital control is much tighter than it was in 2015, it offers more room for the PBoC to use the exchange rate as demand tool as opposed to 2015 as the pressure on outflows should remain tamed.

Given that growth deceleration is faster and the monetary transmission mechanism is less effective, the government’s growth target will be hard to achieve without a bigger – and more effective – fiscal stimulus. Since we are already in the third quarter of 2019, quick fixes out of fiscal measures seem unlikely. This means that only a trade deal with the US can shore up business sentiment. If a trade deal cannot be achieved, exchange rate appears as the only quick fix in town to increase external demand, at least temporarily. However, such disruptive tool will probably not be used during the ongoing negotiations with the US, as trade deal is still a better way to boost external demand than competitive devaluation. In the long run, for China’s structural deceleration to be smoothed out, the fundamental solutions are reforms and further opening-up of the economy.

All in all, the Chinese government still has weapons in its toolbox to stabilize the economy in 2019 but much less than in 2015. The only more effective short-term instrument today is capital controls, which opens the door to RMB depreciation if push comes to shelf. However we are still not there because a trade deal is a better option. Given China’s more limited room to push up growth, and the increasingly negative environment, we would lower our GDP growth forecast from 6.3% to 6.1% in 2019, and from 6.2% to 5.7% in 2020. 

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