China has been on the verge of a hard landing for many years, according to some analysts. Will they finally be right in 2019? In the latest issue of Sinology, Andy Rothman, Investment Strategist at Matthews Asia explains that in the fourth quarter of 2018, China’s economic deceleration was not significantly sharper than he expected, and several policy changes should lead to stronger activity and market sentiment in the second half of this year. In his opinion, a hard landing is still not on the horizon.
He believes that "everyone paying careful attention to China should have expected the year-on-year (YoY) growth rates of almost every aspect of the economy to slow a bit last year,but that it is still the world’s best consumer story... Services now account for 44.2% of household consumption, up 1.6 percentage points from a year ago." Rothman also points out that manufacturing, excluding autos, is healthy, as well as property investment.
Considering that the degree of economic growth deceleration last year was largely within his expectations, Rothman points out four reasons why market sentiment in China abysmal:
- Fear of a trade war with the U.S.
- Concern that during the first three quarters of last year, Chinese leader Xi Jinping voiced strong support for state-owned enterprises (SOEs), while expressing little love for the private firms
- The unintended consequences of the government’s efforts to de-risk the financial system.
- A cloud of regulatory uncertainty
However, he believes that sentiment is likely to improve in the second half of this year, given that he expects a 1H19 resolution to the short-term trade dispute between the U.S. and China. :Trump seems to believe that resolving this problem and lifting his tariffs on Chinese imports is important to his re-election prospects, and he has therefore adopted a more realistic negotiating strategy, dropping his irrational focus on the bilateral trade deficit as well as demands for Xi to make deep structural changes, such as eliminating his industrial policies and support for SOEs. I think Xi recognizes that Trump’s remaining demands, including better market access for American firms and stronger protection for intellectual property rights, will contribute to China’s economic progress, and Xi also wants to avoid a conflict that could escalate into a tech war, jeopardizing China’s access to US semiconductors. A Trump–Xi deal will not resolve the longer-term challenges in the bilateral relationship, but it will lift short-term fears of an escalating trade war."
The second reason to expect better sentiment in China, according to Rothman is that Xi has already pivoted away from his rhetorical embrace of SOEs, with recent public statements expressing support to entrepreneurs. "His banking regulators have also announced a series of measures designed to boost lending to private firms. While it isn’t clear how effective those measures will be, the impact on entrepreneurial sentiment should be apparent in the coming quarters."
He considers modest easing of monetary and fiscal policy is a third reason for optimism this year. "China’s banking regulators have indicated that they will take steps to mitigate the impact of the shadow banking crackdown, including increasing interbank liquidity, which will lower interbank rates. Mortgage rates have already begun to decline. This will be accompanied by modest fiscal policy easing, including further tax cuts and a small boost to infrastructure spending. Because the economy remains reasonably healthy, these policy fine-tuning measures will fall far short of a dramatic stimulus, and their objective is to boost sentiment and ensure the macro deceleration remains gradual, rather than to reaccelerate growth."
Rothman also expects policy fine-tuning in the residential property sector with Chinese likely to buy another 12 million new homes this year, with a minimum of 30% cash down.
"Finally, although regulatory uncertainty will remain a fact of life in China for many years to come, investors are likely to see more clarity on some specific issues, including a relatively benign impact on company profits from more effective collection of social security taxes. All of these factors, along with relatively low valuations in the A-share market, are likely to result in better sentiment among domestic investors in the second half of this year." He concludes.