China’s Slowdown

 

Washington’s growing hostility is complicating China’s efforts to gradually move away from the debt-driven investment model of the past decades to a more consumer-driven service economy. Weaning the economy from the previous growth-model was never going to be easy, but growing U.S. antagonism may be hurting confidence and affecting growth prospects. In any case, signs of slowing growth are everywhere and will increasingly impact the domestic political process.

The Chinese growth model has been based on exports, urbanization and infrastructure development. On the one hand, the export growth model has reached its limits because of resistance from trading partners and the rising cost of manufacturing in China. Foreign investors that played a major role in exports are now relocating to cheaper sites such as Vietnam and Mexico. On the other hand, urbanization and infrastructure development, are well advanced and will not have the same impact on growth as in the past. Moreover, these sources of growth were debt-funded, and China is probably close to the end of a cycle of debt accumulation. The chart below shows the remarkable increase in borrowing that has fueled growth since 2008. China responded to the Great Financial Crisis with a huge debt-financed fiscal expansion, largely aimed at supporting infrastructure and urbanization projects. At the same time, household lending, primarily for real estate, took off.

 

The lending boom led to a surge in real estate prices and enormous fortunes for developers.

However, in recent years the government has grown increasingly weary of both debt levels and real estate speculation. Starting in 2016, measures were introduced to restrain lending. The chart below shows the year-on-year growth of lending according to China’s “total social lending” concept. This lending growth is now a th lowest level in 15 years and barely above nominal GDP.

China’s lending restrictions were aimed mainly at “shadow bank lending,” which are creative vehicles that banks used to channel credit to private borrowers at higher rates. This source of lending, which was vital for private businesses and speculation, is now in sharp decline, as the chart below shows.

Construction spending, which has been the main driver of Chinese growth for decades, is very closely tied to bank lending, as shown below. As bank lending growth declines, it is no surprise that construction activity is also stabilizing.

These tighter financial conditions are starting to have a broad impact on the economy.  Housing prices have now stopped rising in China’s main cities; car sales are falling for the first time in years; and retail sales are soft. We can see this in the three following charts:

China’s slowing growth is structural in nature. Given the size of the economy now, it is no longer possible to run large current account surpluses. China’s population is ageing very fast, more like a developed nation than an emerging market, and the labor force has been declining for several years.

The government’s strategy to manage slowing growth is three-pronged: continued urbanization of second and third-tier cities and rural development; increasing the share of household consumption in the economy; and promotion of initiatives to dominate frontier technologies, the so-called “Made in China 2025” industrial policy.

This is a reasonable policy but for it to work it requires a stable transition. This is occurring at a time when domestic politics appear to have become tense, with a debate raging between hardline “big state” authoritarians and “free market” reformers. Growing U.S. hostility will not help, and managing slowing growth and high debt levels will be a challenge.

 

Macro Watch:

  • The emergence of the petro-yuan (APJIF)  
  • A users guide to future QE (PIIE)
  • Economic brake-lights (Mauldin)

Trade Wars

  • China’s tantrum diplomacy   (Lowy)
  • Making sense of the war on Huawei  (Wharton)
  • The war on Huawei (Project Syndicate)
  • Trump pushes China to self-sufficiency (SCMP)
  • The road to confrontation (NYT)
  • The real China challenge (NYT)

India Watch

  • Modi’s election troubles (WSJ)
  • India’s air pollution problem (FT)
  • India’s mutual fund industry (CRISIL)
  • Election uncertainty clouds Indian stock market (FT)

China Watch:

  • China’s radical experiment (Project Syndicate)
  • China picks tobacco taxes above public health (WIC)
  • How free is China’s internet? (MERICS)

China Technology Watch

  • Will China cheat U.S. investors in tech stocks (WSJ)
  • The Huawei security threat (Tech Review)
  • China’s Big Tech Conglomerates (IIF)
  • How China raised the stakes for EV  (WEF)
  • A profile of Bytedance, China’s short-video app (The Info)

Brazil Watch

  • John Bolton’s Troika of Tyranny (The Hill)
  • The rise of evangelicals in Latin America (AQ)

EM Investor Watch

  • In pursuit of prosperity (Mckinsey)
  • What drives the Russian state? (Carnegie)
  • Russia’s big infrastructure bet (WSJ)
  • Russia’s new pipeline (Business Week)
  • Indonesia’s elections (Lowy)
  • Chile’s renewable energy boom (Wiley)

Tech Watch

  • Bloomberg energy finance, 2018 report (Climatescope)
  • Fast-tracking zero-carbon growth (Ambition loop)
  • Why have solar energy costs fallen so quickly (VOX)
  • Asia leads in robot adoption (QZ)
  • The new industrial revolution (WSJ)

Investing