China growth to slow, economy to remain strained

Beijing

CHINA'S economy will remain strained next year as deleveraging is set to continue and the trade war hits its supply chain and exports sector, analysts say.

Growth will continue to slow to under 6.5 per cent with pressure coming from a slump in the property market, uncertainties around trade and a general slowdown of the global economy.

However, analysts add that the government has plenty of leeway to support the economy. They remain optimistic for the outlook next year with growth slowing but staying above the 6 per cent threshold.

"In the last few years, China benefitted from cordial relations with the western world. China was able to benefit from World Trade Organization rules and ship their products easily. This is no longer the case", said Vincent Chan, the head of China Equity Strategy Research at Credit Suisse.

In this sense, 2018 has been a turnaround year on many fronts.

Beijing has had to adapt to US President Donald Trump's erratic governing style and assertiveness.

Chinese companies are facing resistance not only in the US and Europe, but also all along the Belt and Road. Lingering tensions with the US, China's main trading partner, turned into a full-blown trade war in July that shows no sign of abating into 2019.

Despite a three-month truce agreed on earlier in December, analysts do not expect tensions to dissipate anytime soon.

The tensions have had trickle-down effects on the whole economy from the electronics supply chain to consumer confidence and pressure on the currency. The stock market has dropped 35 per cent over the past 12 months. The property market, a backbone of the economy, is stalling and should not pick up significantly in 2019. The auto market is expected to contract in 2018, after rising for more than 30 years.

Next year, targeted industries by the trade war such as steel, consumer goods will decelerate. Trade will also slow with exports falling to just over 5 per cent growth.

While employment has held up, this might not be the case looking forward. Citigroup sees up to four million layoffs linked to the trade war as part of the global supply chains shifts permanently to other Asian nations.

"It's a reality that China is losing some of its cost competitiveness, especially in labour-intensive and low-value-added sectors," said Lui Li-Gang, an economist with Citi in a 2019 outlook report.

"Although shifting the supply chains is not feasible in real time, manufacturers may seriously weigh the option of leaving China if punitive tariffs last longer than expected."

Further tariffs on Chinese imports as threatened in 2019 by the Trump administration could slash 1 to 1.5 percentage points off GDP growth.

This adds on to the structural changes Beijing is imposing on companies and local governments with the long-term goal of rebalancing the economy. This has led to pressure on banks to clean up their balance sheets and companies moving up the value-added chain.

To offset any sharp slowdown of activity, the government has stepped in to boost infrastructure projects, loosen credit conditions and monetary policy. Small and medium-sized firms have benefitted from several tax cuts.

Such measures should continue next year as Beijing eases its deleveraging campaign. Analysts expect requirement reserve ratio rates to fall further as well as more fiscal easing. These could well result in a pickup of GDP growth after the first quarter.

However, it is unlikely the government will resort to a massive stimulus such as in 2008-2009 which straddled local government and banks with billions in bad loans.

Other indicators that will be watched include: inflation which is nearing deflation, corporate profitability and employment.

"Deleveraging might slow down but will continue. The debt-to-GDP ratio is stabilising. China will encourage investment but will not take pressure off the banks. The government will try to push banks to lend to SMEs. Liquidity will also improve. Unless the economy really slows they can accept some slowdown," said Credit Suisse's Mr Chan.

Credit Suisse expects investment to grow 10 per cent next year, against 3 per cent this year, with GDP growth to slow to 6.2 per cent and trade at 5.1 per cent.

Analysts, however, are worried if banks can weather another round of bad debt after three years of deleveraging.

"With the economic slowdown, we will see non-performing loans rise. Small commercial banks that have weaker fundamentals will be the most vulnerable," says Chua Han Teng of Fitch Solutions, who sees growth softening to 6.4 per cent in 2019 and export growth at 5 per cent.