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Economic Insight: Greater China

ICAEW Economic Insight: Greater China is a quarterly economic forecast for the finance profession, produced by Oxford Economics.

Growth moderates after two quarters of robust growth: Q3 Summary

  • Regional GDP is expected to grow 6.7% this year, up from 6.6% in 2016.
  • China’s economy maintained steady growth in Q2 with real estate activity in the smaller cities remaining buoyant. China’s growth to cool on slower growth in real estate and less accommodating monetary policy, but more gradually than anticipated a few months ago.
  • Downside risks to exports remain, in particular in the area of US-China trade relations.
  • Robust domestic demand and solid export growth boosted Hong Kong’s GDP growth in Q2. The economy is forecast to grow by 3.5% this year (up from 2% in 2016). 
  • Macau’s recovery remains on track, led by the gaming and tourism industries. 

China’s economy slows on weaker exports and real estate activity

Following stronger-than-expected growth in H1, China’s economy slowed in July on weaker exports and real estate activity.  Goods exports growth moderated at the beginning of H2, dragged down by softening demand in Asia, even as exports to the US, Europe and other non-Asian regions gathered pace.  Looking ahead, we expect the external setting to remain broadly supportive in the rest of 2017, but less than at the start of the year. Amid cooling import growth in Asia, we do not see demand growth in the US and Europe rising significantly over the rest of the year. In this setting, China’s export growth probably peaked in Q2, in real terms, and is likely to be more moderate in H2. Downside risks to exports remain, in particular in the area of US-China trade relations following strong growth in Chinese exports to the US and a widening of the bilateral trade deficit amid tensions over North Korea.
The US government announced the start of an official investigation into China’s intellectual property practices, which could trigger US trade protectionist measures against China and potentially a trade war as China has signaled it is ready to retaliate.On the domestic side, China’s housing market held up better in the first half of this year than we had anticipated, supported by buoyant activity in the smaller Tier 3 and Tier  4 cities where the housing policy stance remains accommodative. As these smaller cities account for around 60% of nationwide housing starts and sales, the recovery in these real estate markets provided a helpful buffer to the slowdown in Tier 1 and Tier 2 cities, where local governments imposed housing purchase restrictions in September 2016. Real estate activity slowed notably in July. Housing sales rose by a meagre 0.3% y/y and housing starts fell 3% on the year. Momentum in overall real estate activity will slow further over the rest of the year owing to a less accommodative monetary policy stance and spill-over effects on sentiment from the slump in housing activity in the large cities. 

Tightening of macro stance is gradual and moderate

Strong growth in the first half of the year emboldened policymakers to tighten the overall macro stance. They engineered higher market interest rates and tightened regulation on shadow banking and local government financing. These changes raised some concerns in the market about tighter monetary policy stifling economic growth. However, we think these are overstated.

The monetary conditions index (MCI) can act as a leading indicator and largely explain the variation in cyclical indicators such as housing starts. It shows that overall conditions have been broadly neutral since mid-2016, even though the credit component turned slightly negative since September last year. Based on our forecast for credit growth, interest rates and the exchange rate, we think that monetary conditions will remain broadly neutral for the rest of the year. This is consistent with slower economic momentum but there will not be a sharp deceleration in growth. 

While we expect the People’s Bank of China to keep interbank rates relatively high, we do not expect a rise in benchmark rates this year as inflation is forecast to stay comfortably below the 3% target. Moreover, we estimate that the target for overall credit growth this year is 13.8%, compared to 16.1% in 2016, and recent trends show that overall credit growth is easing  slowly towards that targeted pace. Looking further ahead, we expect credit to continue to outrun nominal activity in the coming years. 

The prospect of policy change at the Plenum

The 19th Plenum of China’s Communist Party, likely to be held in October, is a major political event. Many senior jobs will be reshuffled, including five of the seven seats on the Standing Committee of the Politburo. There is widespread consensus that, in the run up to the Plenum, China’s senior leadership just wants stability on all fronts and will not want to undertake significant changes in the economic and financial policy stance. While things cannot be taken for granted, signs are that President Xi Jinping will be quite successful in strengthening his position in terms of seeing his preferred candidates take on senior positions. 

While economic policy will not feature prominently at the Plenum itself, many observers speculate  that Xi’s position is strengthened following the event, while significant changes in economic policy will be introduced. Key questions are whether there will be greater willingness for potentially disruptive reforms and how to balance growth with reform and deleveraging.

We do not expect a major shift in the stance on these issues. In our view leaders will continue to put emphasis on stability and gradual rather than abrupt change. While there is interest in further reforms, we think that there is little appetite for steps that are economically or politically risky. Moreover, there are signs of a lack of consensus at the senior level on economic policy and reform, which further reduces the likelihood of rapid changes.

China enters the final quarter with solid growth momentum

Hong Kong and Macau outlook

Hong Kong’s economy grew by 4% y/y in the first half of the year – its fastest expansion in six years. Growth was underpinned by robust domestic demand and a fairly healthy export performance. The acceleration in private consumption and investment spending in Q2 reflects improved confidence among domestic households and companies.This bodes well for solid demand momentum to continue in H2, provided the city’s buoyant asset prices, especially in the property market, do not experience sharp corrections.

Externally, we expect faster global trade to continue to support Hong Kong’s exports in the coming months, although their year on year growth may ease further in H2 as Chinese import demand moderates. Following the surprisingly positive Q2 outturn and reasonable outlook for domestic and external demand in H2, we now forecast that GDP will grow by 3.5% this year (up from 2% in 2016).

Macau’s economy grew by 10.9% in the first half of this year, after shrinking by a cumulative 24% in 2014-16. The recovery in the services sector gathered more momentum, driven by rising tourist arrivals which also sparked the city’s casino revival. Gross gaming revenues rebounded for the 12th consecutive month through July following 26 months of y/y declines, with VIP revenue growth overtaking the mass market in Q2 for the first time in nearly six years. While a resurgence in VIP gambling bodes well for short-term prospects, we remain cautious on how sustainable such growth momentum will last amid tighter monetary policy and capital controls on the Mainland. Domestically, we expect private consumption to sustain its recent momentum in H2 on a solid labour market and firming house prices. Overall, we forecast GDP growth to rebound to 7% this year. 

Economic Insight reports are produced with ICAEW's partner Oxford Economics, one of the world’s foremost advisory firms. Their analytical tools provide unparalleled ability to forecast economic trends.

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