Source: Euromonitor International Macro Model
China’s GDP growth, consumer confidence and other indicators of economic activity were somewhat better than expected in the first quarter of 2017. Therefore, we have upgraded our outlook, with GDP forecast to rise by 6.6% in 2017 and 6.1% in 2018. In its March 2017 National People’s Congress, the government reemphasized it willingness to accept moderate declines in growth in exchange for greater financial stability. Cuts in heavy industry production capacity are also expected to continue, though at a slower pace than in 2016.
The improved outlook also reflects lower short-term risks of a trade war or more general confrontation with the new US administration. The power of more moderate advisors in the Trump administration has increased in the last two months, signalling a partial shift towards more mainstream Republican positions. The US treasury avoided labelling any country as a currency manipulator (as promised by Trump for China during the presidential campaign) in its recent report on exchange rate policies. However, China and other Asian countries were kept on a watch list for potentially unfair exchange rate manipulation.
In this context, the first meeting between Chinese president Xi Jinping and US president Donald Trump went relatively smoothly. The two presidents agreed to improve China-US economic relations with a 100-day action plan, and to cooperate on containing North Korea’s military threats. Subsequent to the meeting, China and the US reached an agreement to increase access to Chinese markets for US exporters of agricultural products, financial services and natural gas.
Despite the signs of improving relations, significant risks of higher trade tariffs on some Chinese exports or even a trade war over the next two years remain. At the end of April the US commerce department launched investigations of potentially unfair aluminium and steel imports competition from China and other countries, which could lead to punitive tariff hikes. In response to these risks and the decline in growth potential for trade with the US and Western Europe, China is trying to diversify its export markets. In mid-May, China hosted an international conference on its “One Belt One Road” plan for reviving trade along the ancient Silk Road and expanding trade ties with other countries such as Indonesia and Russia. China’s economic rebalancing should also diminish trade risks over the next five years, as the already dominant role of domestic demand in the economy keeps growing.
The ongoing fast credit expansion continues to pose a threat to China’s economy. In our main downside scenario an unexpectedly abrupt reversal of credit availability, combined with a decline in private sector confidence, lead to a major downturn. Output growth would decline to 5.8% in 2017and 3.7% in 2018. We assign this scenario a 10-20% probability over the next year.
The main upside scenario would involve a combination of a moderate fiscal stimulus beyond current spending measures, together with unexpectedly high growth in business and consumer confidence. Chinese GDP growth would reach 7.1% in 2017 and 7.6% in 2018. We assign this scenario a 15-20% probability over a one-year horizon.
More severe tail risks remain substantial. A much stronger than expected tightening of credit conditions and bottlenecks in the economic rebalancing process could cause a hard landing, reducing annual GDP growth by 3% in 2017-2019. We assign this scenario a 10-28% probability over a two-year horizon. The risks of a trade war with the US have diminished since February, but are still significant. We now assign this scenario a 15-25% probability over a two-year horizon.
Source: Euromonitor International Macro Model
Output and Economic Activity
China’s GDP increased by 6.9% year-on-year in the first quarter of 2017 (up from 6.8% growth the previous quarter), beating expectations. As in previous quarters, service sector growth of 7.7% exceeded the weaker 6.4% growth in the construction and manufacturing (secondary) sector. Services accounted for 56.5% of GDP in the first quarter, compared to 38.7% in construction and manufacturing.
Nominal fixed investment increased to 9.2% year-on-year in the first quarter (compared to 8.1% growth in 2016). While SOE investment growth was still significantly faster than average at 13.6% year-on-year, the gap with the private sector has diminished. Private sector nominal fixed investment rose by 7.7% year-on-year (compared to 3.2% in 2016), reducing previous concerns about excessive allocation of credit to SOEs.
Looking at monthly indicators, industrial production growth increased unexpectedly in March to 7.6% year-on-year, but declined to 6.5% in April. Retail sales growth increased towards 9% year-on-year in the first quarter, but declined in April. Purchasing manager surveys suggest a slower improvement in business conditions in March and April. However, business and consumer confidence remain significantly above average. While output is expected to decelerate in the next quarters, growth should still hit the government’s “around 6.5%” target for 2017.
Credit Markets and Monetary Policy
Private sector and SOE debt levels have continued to rise faster than GDP in recent quarters, with lending growth of 12-15% year-on-year (depending on the precise measure). Broad money supply growth (another measure of the speed of credit expansion) has declined slightly during the first quarter of 2017, but is still close to 11%. While high corporate lending growth is still a significant concern, mortgage loans have become more prominent recently, accounting for 45% of new credit in 2016. This has contributed to an average (across 70 cities) house price growth of 11.3% year-on-year in March and 10.7% in April 2017, with some cities reporting price increases of 15-25%. In response, during the first quarter of 2017 21 cities imposed various restrictions on residential lending, such as raising down-payment requirements on second mortgages to 60%.
The People’s Bank of China (the central bank) has continued to issue new warnings to banks to reduce property lending. It also increased several of its lending rates in March by another 0.1-0.2 percentage points, while maintaining the main one-year lending rate unchanged. Chinese financial regulators issued new guidelines to banks in April for improving risk control and loan quality. Recent government statements suggest further tightening of regulations on shadow banking products are forthcoming.
There are signs these measures are starting to have an impact. The issuance of new shadow banking products declined by 35-39% in April. Since the end of 2016, the 3-months interbank interest rate has increased by around 1 percentage point to a 2-year high. This has tightened borrowing conditions for smaller banks and non-bank financial institutions (shadow banks) that have accounted for most of the recent debt build-up, and are the main users of the interbank market. The credit spread between municipal and central government bond yields has increased by around 0.5 percentage points, raising borrowing costs for local governments. Government policy faces a significant challenge in stabilising credit growth without precipitating a credit crunch. Our baseline forecast assumes the government meets this challenge, leading to a smooth reduction in economicgrowth with a stabilisation in debt to GDP ratios. However, significant downside risks remain.
Euromonitor International strategy briefing Global Economic Forecasts: Q2 2017 offers further insights on the global economy and provides the latest global macroeconomic projections.