The Chinese economy continues to be a concern to the rest of the world. The information we are getting paints a picture of economic frailty and financial fragility — and that policymakers’ efforts since last year to turn the economy around have not worked well. However, following a series of statements from leaders and senior officials at the National People’s Congress, it is now clear that China’s leaders are so worried about the state of the economy that they are pulling out all the stops to stimulate it. The new measures strike us as well-targeted and likely to be effective. Indeed, we believe that China could deliver a powerful upside surprise in economic growth in the next few months, with substantial spillovers to Southeast Asian economies.
Right now, the Chinese economy is not yet out of the woods
Recent data shows that domestic demand remains feeble, despite the concerted rollout of support measures to boost consumer and business spending. Demand for China’s exports has been disappointing, which is not a surprise given how poorly global demand has been performing.
• Impact of a weaker global economy: Exports sank 20.7% y-o-y on Feb 19 — the steepest contraction in three years. Looking into the details of the slowdown, it is clear that the distortions from the timing of Chinese New Year do not explain all of this contraction since exports fell 4.6% in January to February as a whole. While some of the deceleration can be explained by the high base from last year, it is clear to us that a weaker global economy has a much lower appetite for China’s manufactures. Our lead indicator for global demand for Asian exports continues to trend downwards as well. Not surprisingly then, the Purchasing Managers’ Index survey shows that new export orders received by Chinese producers have continued to decline. In fact, the export order sub-index of the PMI fell further to its lowest level in a decade. It will certainly take a while before we see exports providing support to the Chinese economy.
• Domestic demand is not helping, yet: Consumers and domestic businesses are not growing their spending enough to offset the drag on growth from exports. This is seen in the loss of momentum in the services sector. The Caixin-Markit services PMI fell a worrying 2.5 points to 51.1 on Feb 19. Forward-looking data in this survey was discouraging, with service providers reporting that their order books were falling — not a good sign for future activity. Another sign that all is not well, even in the domestic economy, comes from the behaviour of producer prices. Producer price inflation has virtually disappeared, with producer prices up a sickly 0.1% year on year on Feb 19, similar to the pace in January, which in turn was the slowest pace in 2½ years. This is more concerning than it sounds. After all, if weak demand is forcing firms into aggressive price discounting, then their cash flows will fall. In an economy with very high debt levels, these cash flows are needed to ensure that loans are paid back on time. Price weakness is a warning of possible future problems with bad loans.
• Stimulus not feeding through to demand quickly enough: Policymakers had stepped up their stimulus efforts from the middle of last year. Yet, what the above developments tell us is that the stimulus is not as effective as hoped. If one looks at the monetary data for January and February, it tells us why: Total social financing (a uniquely Chinese measure that gives a good read on how much monetary stimulus there
really is) bounced up only slightly to 10.3%, from 9.8% in December, which had been a record low. The message is clear — credit is growing but not quickly enough to turn the economy around.
• China’s problems hurt the rest of the world: China is importing less from the rest of the world. Its imports contracted 5.2% y-o-y on Feb 19, the third consecutive monthly decline, and even worse than the 1.5% fall in January. This weakness in Chinese demand almost certainly explains at least a good part of the sharp fall in industrial orders in Germany in January. Worries about the Chinese economy have also depressed business confidence generally, causing companies to hold back on spending and hiring — which has also hurt the global economy.
Chinese leaders are rattled, and they are responding vigorously
Over the past few weeks, it has become clear that Chinese leaders, from President Xi Jinping to all the way down, are focused on the downside risks. Xi kept emphasising the need to contain risks in important speeches he made last month. Premier Li Keqiang’s statement to the National People’s Congress reflected this concern with the frequent use of phrases such as “instability”, “uncertainty” and “downward pressures”. Li also announced an “employment-focused” policy that will target creating 11 million new urban jobs so as to keep the unemployment rate under 5.5%, betraying his worry that a lack of jobs could aggravate social tensions.
There is thus no doubt that Chinese policymakers fully appreciate the downside risks and are determined to ensure that the economy bounces back as soon as possible. A quick overview of the measures announced recently supports this:
• Big increase in spending: Li used his speech to outline more budgetary support to shore up the economy. The fiscal deficit will rise to 2.8% of GDP from 2.6% in 2018. Even though he emphasised that there would not be “a deluge of stimulus policies”, it is clear that the additional demand generated will be quite sizeable. When one adds in other indirect government spending, the scale of the spending surge is even greater, with some analysts estimating it at above 4.5% of GDP. The government plans to spend 800 billion yuan (RM486 billion) on rail projects,
1.2 trillion yuan on roads and waterways as well as 580 billion yuan on IT infrastructure — these are all high-multiplier types of spending that should achieve a fairly quick boost to demand.
• Tax cuts to help businesses: Li also announced reductions in taxes and fees to the tune of almost 2 trillion yuan, hugely up from 1.3 trillion yuan in 2018. Most significant was the cut in value-added tax on the manufacturing sector — which will fall to 13% from 16% currently. The VAT rate on the transport, construction and related sectors will also be reduced to 9% from 10%. The tax relief will amount to about 2% of GDP, quite sizeable considering that the corporate tax burden in China is currently among the highest in the world at over 20% above the global average.
• Monetary policy to be deployed more aggressively: The government also announced that it would boost the share of bank lending accruing to small and medium-sized enterprises to 30% in 2019, up from 20% in 2018. This shows that it has understood that a major problem has been the lack of credit flowing to the most dynamic parts of the economy — the private sector. More significantly, a senior banking regulator told the press that the government was thinking of even allowing a return of some shadow banking operations as long as their lending “benefits the real economy” and did not aggravate financial imbalances by supporting speculation. The signal from policymakers is that they will now pursue a more nuanced policy regarding financial risks. Instead of clamping down on all forms of informal financing, regulators would now try to differentiate between good and bad shadow banking operations.
A sharper than expected turnaround is on the cards
China’s leaders have heeded warnings from economists that policy transmission mechanisms had weakened in recent years and that the policy response had to be refined and made more targeted in order to be effective. The latest set of corporate tax relief is sweeping and will probably succeed in turning the economy around:
• First, it is the credit-starved private sector parts of the economy, not the inefficient state enterprises, that will now get an infusion of credit. Experience shows that when credit-constrained companies finally obtain loans, they tend to raise their spending quite quickly. Second, the tax relief will also help the over-burdened corporate sector the most.
• Second, the government remains focused on ramping up infrastructure spending because it knows this will boost the economy directly, not leaving much to chance.
The key to us is that the measures are targeted at precisely the bottlenecks that kept the economy from responding to the previous stimulus efforts. This means that we could well get a surprisingly strong pickup in economic activity in the next few months — a huge reversal from the gloom that is currently pervasive. It is very likely, in our view, that the economy will rebound sharply by the beginning of the third quarter. We would not be surprised, in fact, if the rebound overshoots the policymakers’ expectations.
Conclusion: This will be very positive for Southeast Asia
In this scenario, the spillover benefits for the rest of developing Asia will be strong and manifold:
First, global business confidence will improve as the evidence of stronger demand prospects out of China grows. Pent-up business demand as well as capacity expansion intentions that had been put on hold because of uncertainty will resume, supporting a recovery in global demand. In addition, the improved perception of risk should encourage portfolio investors to reallocate capital back into the region’s bond and equity markets.
Second, as a result, commodity prices will rise as markets begin to recognise the effectiveness of the stimulus. For our region, the key commodity prices that tend to rise with a recovery in global demand would be rubber, thermal coal and base metals such as copper and nickel — all of which a country like Indonesia exports.
Third, China’s demand for components and intermediate inputs that Southeast Asia manufactures should also grow faster as a result.
Fourth, the recovery should help bolster confidence in the Chinese renminbi, allowing it to firm. A stronger yuan would provide relief from downward pressures for the more vulnerable currencies in the region such as the rupiah.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy