Pain underneath the headline GDP
China’s economic deterioration since mid-2018 was likely understated. Reported real GDP recorded a relatively gentle slide from 6.7% in Q2 2018 to 6.4% in Q4 2018. Conversely, Q4 current activity trackers placed China’s growth lower at 5.1-5.5% s.a. annualized range.
Indeed, the pain was much more apparent from a bottoms-up perspective. Weighed down by weak household consumption, business investments and poor export orders, industrial enterprise profits sharply contracted from 1.9% yoy in Dec 2018 to 14% yoy during Jan-Feb 2019 on the back of PPI disinflation, falling margins and the weakest industrial output growth since the Global Financial Crisis in 2009. In particular, February’s industrial output weakness was fairly broad-based across state-owned enterprises, private sector, joint stock and foreign firms alike with both traditional and high-tech sectors under pressure. Consumers also curtailed discretionary spending as labour market conditions worsened, impacting purchases of automobiles, home appliances, electronics, jewelry and property-related products. Nationwide unemployment rate worsened quite sharply from 4.9% in December 2018 to 5.2% in March, as firms that had been affected by the US-China trade wars laid off workers.
Sharp Synchronized Global Output Correction
The global spillover impact of China’s economic weakness and the US-China trade wars that it was afflicted with was notable. Our bottom-up observations since last June tracked fairly broad-based supply chain disruptions impacting Korean and Taiwanese semiconductor manufacturers, Japanese industrials and automation firms, European capital goods and automobile manufacturers, shipping orders and consumer electronics, amongst others. With the World Economic Forum estimating that China will dominate 33% of all global GDP growth (PPP) and Asia as a whole accounting for 63%, while Latin American and Euro Area account for 3% and 7% respectively, we were not surprised that the IMF warned that 70% of the global economy is experiencing a growth slowdown.
Where do we go from here?
We detect a significant upshift in credit expansion plans. We expect Total Social Financing growth to accelerate which should be able to notably kick-start and fund a government-initiated multi-year infrastructure program which should act as a circuit breaker to the economic slump arising from a lack of orders (domestic and external). Q1 2019 newly increased TSF was up +40% yoy, reversing four quarters of double-digit decline. Local government (LG) special purpose bonds and onshore LG financing vehicles have been issuing bonds at a faster pace to finance projects which commenced after the rainy season and environmental controls during the March National People’s Congress. New medium and long-term corporate lending has also risen as a share of total loans, benefiting infrastructure, property and private enterprise financing.
Accordingly, we observed endogenous and government-initiated fiscal levers helped to anchor a turnaround in fixed asset investments as well as boost industrial output in March, which helped to stabilize China’s slowing economy at 6.4% yoy during Q1 2019. Looking ahead, we note forward-looking indicator new orders to inventory ratio recovered to the highest in 6 months, supporting raw material inventory restocking from 46.3 in February to 48.4 in March while TSF trajectory also points to credit-assistance for further recovery ahead.
Subject to trade talks and the pace/magnitude of the fiscal expansion, we expect China to be able to deliver steady GDP growth for 2019 mainly on the back of stronger 2H 2019, with further acceleration likely to persist into 2020. As a counter to trade wars, infrastructure stimulus can now be funded by the credit creation by the banks and credit reallocation from shadow banking activities to the real economy.
The risk of the authorities’ current path is that a much larger-than-intended front-loading of fiscal stimulus will negatively impact Public Debt Sustainability and FX Reserve Adequacy (risks of over-stimulus spark fears of capital flight at a later stage). With IMF estimates placing China’s augmented debt levels close to 80% of GDP by 2020, authorities will have to carefully manage the build-up of contingent liabilities at the local level again as it embarks on its credit-assisted strategic investment focus on transport infrastructure, urbanization (city level clustering) as well as advanced manufacturing.