Economic Update: Greater China
ICAEW Economic Update: Greater China is a quarterly economic forecast for the finance profession, produced by Oxford Economics.
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Slower regional growth amid the flare up of US-China trade tensions
- Regional GDP growth seen at 6.2% this year, after an estimated 6.5% in 2018.
- China’s growth is expected to soften further in Q2 amid the re-escalation of US-China trade tensions, before stabilising later in the year in response to macro policy easing.
- Hong Kong’s economy is expected to grow at a much slower pace this year amid the darkening export outlook.
- Macau’s growth is set to slow this year amid a cooling Chinese economy and the US-China trade tension.
Real GDP growth
Global growth momentum in Q1 2019 has proved to be stronger than we had previously expected, particularly in advanced economies and also in China. However, following the renewed escalation of US-China trade tensions, we have become less optimistic about the Chinese economy, although we still expect growth to stabilise later in the year in response to policy easing. Slower growth in China and the US will put pressure on global growth to some extent. Overall, we forecast global GDP growth to slow from 3.2% last year to 2.7% in 2019 and 2.8% in 2020.
We still think that the global economy is not heading for a recession, but downside risk is rising as the possibility of a further increase in trade tensions would obviously have a much larger impact on economic growth. Moreover, US recession risk is seen by market participants as an emerging risk for the global economy, while a sharper slowdown in China, financial market turmoil and a disorderly Brexit remain key risks to the economic outlook.
China: Downward pressure increases on new trade tension
US-China trade negotiations took a sharp turn for the worse in May. The US raised tariffs on US$200bn of Chinese imports from 10% to 25%, starting from 10 May. China retaliated with tariff hikes on US$60 of US imports from a range of 5%-10% to 5%-25%, effective from 1 June. The US has also announced a possible fourth round of tariffs, covering about $300bn worth of Chinese goods, which will include almost all of the items that have not been covered by the previous tariffs except for some drugs and minerals such as rare earths.
The spike in trade tensions will likely put more downward pressure on China’s growth in the coming quarters than we previously envisaged. While the increased US tariffs will have a direct impact on Chinese exports to the US and hence slow overall trade growth for China, they also hurt consumer and investment confidence in China. But even before trade tensions flared up, China’s domestic and external demand eased in April after seeing a stronger-than-expected GDP growth in Q1 at 6.4% y/y.
In fact, goods exports fell in April after a brief recovery in March. Export volumes rose on average 2.4% y/y in Q1, after 2.1% in Q4 2018, suggesting that global demand remains sluggish on a trend basis.
China's exports to key markets
On the domestic front, overall real consumption grew at an estimated 5.8% y/y in Q1, lagging real disposable income growth. There was evidence that household consumption growth softened further in April as real retail sales growth fell to 5.1% y/y, from 7.1% in Q1, and passenger car sales continued to fall at a double-digit rate year on year. Meanwhile, investment moderated in April from a pick-up in March as manufacturing investment lost steam. These all weighed on industrial production, with the expansion of real valued added in industry down to 5.4% y/y in April from 6.4% in Q1. Credit growth also slowed in April from a strong pick-up in March. But this still represents a significant pick-up from the recent low recorded at the end of 2018, possibly reflecting that the impact of more decisive monetary policy easing since late 2018 is gradually passing through.
Key cyclical indicators
Looking ahead, we expect China’s economic growth to ease further in Q2, before stabilising later in the year in response to the macro policy easing. The government will likely ease macro policy further to counter the downward pressure on growth from weaker exports and investment amid the imposition of higher tariffs by the US and China. These measures could include further reserve requirement ratio cuts, more infrastructure spending and lending to businesses. That said, we still expect policy easing to remain relatively modest this time around compared to previous stimulus episodes, given Beijing’s modest growth ambitions and cautious approach towards raising leverage.
Meanwhile, we think that the existing tariffs imposed on the US and China’s imports will not be lifted any time soon, though we have not assumed further tariff hikes by both sides in our baseline forecast. We forecast China’s GDP to grow by 6.2% in 2019 as a whole and 5.9% in 2020.
Risk of further escalation of trade conflicts has risen
The probability that the US-China trade tensions escalate further has obviously risen. Indeed, recent developments show how difficult it is to achieve agreement on a range of policies and practices on technology, market access and intellectual property, in a way that goes far enough for the US and is acceptable to China.
Further increases in trade tensions would have a much larger impact on economic growth than under our baseline forecast. If the US goes ahead with imposing tariffs on almost all Chinese imports, we estimate that China’s GDP growth would be reduced by an additional 0.4 ppt in 2019 and 0.3 ppt in 2020, in the absence of more policy easing. Even with additional policy support, it would be difficult to fully offset the drag on activity from much weaker trade amid substantial deterioration in sentiment.
Meanwhile, the spike in trade tensions has already rattled financial markets. In particular, the Chinese renminbi (RMB or CNY) has come under pressure to depreciate, weakening a full 2.5% against the US$ to 6.9 in the two weeks since early May when the US President threatened to raise tariffs on imports from China (Chart 4). This has led to renewed questions about the outlook for China’s currency and the potential response of policymakers if it were to get closer to the level of 7 to the US$ that seems a sensitive threshold.
Although we now forecast more RMB weakening in the near term, we continue to expect some RMB strengthening in H2 without breaching the 7 mark. This is consistent with the stabilisation of economic growth in China that we expect to become visible in the coming months, at a time when US growth is likely to ease.
However, if more substantial pressures were to emerge – for instance if the threshold of 7 to the US$ were to be threatened again – we would expect the People’s Bank of China (PBoC) to intervene in order to dampen those pressures. While RMB movements have usually largely been driven by market pressures since mid-2017, with very little PBoC intervention (Chart 5), we think that China’s policymakers feel they should intervene in periods of substantial stress or turmoil. Indeed, the last few times that the yuan was under pressure and not too far off the 7 level – at end 2016, early 2017 and Sep–Nov 2018 – we observed significant PBoC intervention to support it.
Hong Kong and Macau outlook
In Hong Kong, GDP grew by 0.6% y/y in Q1, further down from the modest 1.2% growth in Q4 last year. Net exports were the main contributor to growth, but only because import volumes contracted more than exports. Domestically, government consumption continued to grow at a robust pace. Capital investment was the main drag, while growth in private consumption fell sharply to 0.2% y/y from 2.7% in the previous quarter. Looking ahead, we expect both domestic and external demand to remain under pressure amid slow global demand and the US-China trade tensions. Moreover, the recent recovery in the property market could stall as market sentiment turns. We forecast GDP to expand at a modest 1.6% in 2019 after growing by 3% in 2018.
Macau’s GDP growth slowed to 4.7% y/y in 2018, following a 9.7% expansion in 2017. The slowdown was driven by weaker exports and a sharp contraction of construction investment in H2 2018 following the completion of major infrastructure projects. We expect GDP growth to ease further this year to 3.2%, mainly because of a slowdown in the Chinese economy. But continued integration within the Greater Bay Area should benefit Macau’s gaming and tourism industries and help to propel modest growth in the coming years.
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