China’s growth surprise is just the start
The larger-than-expected slowdown in reported Chinese GDP, to 6.5% from 6.7% in the second quarter, has seemingly spooked markets and pushed policymakers across the institutional spectrum to promise support. However, we think a further slowdown is on the cards given that tariffs have yet to show up in the data, and the incipient, long-awaited weakness in the property sector. Furthermore, the ability to provide policy support faces more constraints than is commonly appreciated.
Consumption the cause?
A breakdown of the GDP data shows the slowdown came primarily from a diminished contribution of final consumption to growth, with investment and net exports apparently stable. Compared to the high frequency data, this is slightly puzzling; the average growth rate of retail sales was essentially unchanged in the third quarter, while the average growth rates of industrial production and fixed asset investment were sharply weaker. Monthly trade data does support an unchanged picture in trade, for now.
Some encouragement for China bulls came from the infrastructure investment data. Though still contracting, the pace has moderated considerably, suggesting that pressure on local governments to accelerate projects is having some effect. This seems likely to continue throughout the fourth quarter, though after that fresh fiscal stimulus will be needed.
Property market teetering
Unfortunately, even as infrastructure spending claws its way back, there are signs that the Chinese property sector is finally beginning to crumble in the face of tighter credit conditions. Mortgage lending and land sales are slowing, and real estate investment has also decelerated. Manufacturing investment has been resilient but will likely face headwinds as tariffs bite. On balance, the outlook for investment is still a challenging one.
On the subject of tariffs, stockpiling inventories or “frontloading” trade ahead of the imposition of tariffs at the end of September has probably been a factor behind the resilience of Chinese trade flows. We would expect October data to show a considerable slowdown. This will harm growth via the net exports channel, but we would also expect it to be reflected in weaker industrial production and manufacturing investment.
Overall then, the growth outlook is not a positive one, and this may have helped spur the initial market sell-off. Policymakers including economics minister Liu He and central bank chief Yi Gang appealed for calm and pledged support, prompting a market rally. The prospect of renewed fiscal and monetary stimulus certainly seems a welcome one given the headwinds the economy faces, yet we think policymakers are more constrained than markets may realise.
The People’s Bank of China (PBoC), for example, continues to claim it will pursue neutral monetary policy and will not weaken the renminbi, which seems to preclude much additional liquidity support. Meanwhile the Ministry of Finance remains somewhat cagey about additional fiscal stimulus; measures so far have simply been an acceleration of planned spending. In the PBoC’s case, the constraint is the fear that flooding the system with liquidity could pressure the currency and undermine the work done on deleveraging and derisking. The Ministry of Finance meanwhile is likely all too aware of the off balance sheet debt of local governments (estimated by S&P recently at $6 trillion) which would massively inflate the overall government debt burden. Additional fiscal stimulus will only add to the risks building there.
We suspect that ultimately fears over financial stability and unemployment will prompt additional stimulus, but that officials will be reluctant to commit to as strong a package of measures as markets might want. This suggests further market turmoil, and more pressure on the yuan, lie ahead.