Short Insight – China: Gradual slowdown continues in Q3

by: Arjen van Dijkhuizen

  • China’s GDP growth drops further in Q3, to 6.5% yoy (from 6.7% in Q2)
  • Mixed activity data for September: slowdown investment comes to a halt
  • Export and import growth still solid, despite escalating trade conflict with US
  • China not labelled currency manipulator, but US Treasury gives clear warning
181019-Short-Insight-China.pdf (272 KB)

1. China’s real GDP growth drops further in Q3, to 6.5% yoy

This morning, China’s real GDP growth rate for Q3-2018 was published. At 6.5% yoy, growth came in weaker than in Q2 (6.7%) and Q1 (6.8%). The slowdown was driven by the industrial sector, whereas growth in the primary and tertiary sectors showed edged up. The ongoing slowdown reflects the impact of the financial deleveraging campaign – with for instance a crackdown on shadow banking – and a slowdown in infrastructure spending. Moreover, the impact of the escalating trade conflict with the US is starting to make itself felt. Although export growth has remained solid so far (see below), the trade tensions are negatively affecting business sentiment and have left their mark on Chinese equity markets. The government has pro-actively taken fiscal measures to offset the (potential) fall-out of the trade conflict, and it is likely that more measures (such as corporate tax cuts) will follow. The PBoC eased its financial deleveraging campaign, and recently cut bank RRRs further by 100 bps . We expect the effects of these support measures to become more visible in the last quarter of this year. All in all, we expect China’s gradual slowdown to continue, with full-year growth falling from 6.9% in 2017 to 6.7% in 2018 and 6.3% in 2019.

2. Mixed activity data for September

The monthly activity data for September published this morning were a bit mixed. Industrial production growth slowed to 5.8% yoy (August: 6.1%), the lowest pace since February 2016. However, retail sales accelerated to a five month high of 9.2% yoy (August: 9.0%). Remarkably, the long lasting slowdown of fixed investment seems to have come to a halt, with growth edging up a bit to 5.4% yoy (August: 5.3%). We expect a further recovery of investment growth in the coming months, following the higher issuance of special purpose bonds by local governments to finance infrastructure projects and other measures taken to support (infrastructure) investment. Earlier this month, the PMIs (both from NBS and Caixin) signaled cooling conditions in manufacturing, but and improving outlook for services. Bloomberg’s monthly GDP estimate, which captures a range of activity indicators, slowed to 6.6% yoy in September (August: 6.8%).


3. Export and import growth still solid, despite escalating trade conflict

Earlier this month, Chinese export growth for September came in better than expected, at 14.5% yoy (up from 9.1% in August, consensus: 8.2%). Electronic exports did particularly well, suggesting that the acceleration in exports may be partly driven by frontloading to avoid new US import tariffs (10% on another USD 200bn) put in place on 24 September. China’s exports to the US grew by 14% last month. Going forward, weak PMI export subindices (dropping further below 50, both for NBS and Caixin) suggest a slowdown of export growth is on the cards. Still, frontloading may continue to support exports in the run up to 1 January 2019, as the US has threatened to raise its tariff rate on USD 200bn to 25% by then. Meanwhile, import growth slowed to 14.3% yoy in September. While that was down from 19.9% in August and a bit below the consensus expectation (15.3%), import growth remains quite solid and has continued to outpace nominal GDP and domestic demand growth by a wide margin. While a slowdown in export growth would likely have a negative effect on import growth (given that part of imports are export-related), recent policy measures such as the stepping up of infrastructure spending and a general reduction of import tariffs should be supportive. Meanwhile, with China’s imports from the US contracting by 1.2% last month, China’s bilateral trade surplus with the US reached a new high of USD 34bn according to Bloomberg data.

4. China not labelled FX manipulator, but US Treasury gives warning

In its bi-annual report on macroeconomic and foreign exchange policies of major trading partners issued last Wednesday, the US Treasury did not label China a currency manipulator. As in April, the Treasury kept China on its monitoring list, together with Japan, S. Korea, India, Germany and Switzerland. That said, the report had a stronger focus on China compared to previous releases, and the language versus China was more hawkish. The Treasury expressed its disappointment over China’s lack of currency transparency and the recent CNY depreciation versus the US dollar.  While China does comply with only one of the three ‘currency manipulation’ criteria, the US Treasury ‘is concerned about the depreciation of the CNY and will carefully monitor and review this determination over the following 6-month period, including through ongoing discussions with the PBoC’. It is highly likely that these issues will form part of (potential) future negotiations between the US and China. Treasury Secretary Mnuchin hinted at the possibility that the presidents of the US and China will meet late November.  In our base scenario, we do not expect CNY to weaken further versus USD, given 1) Beijing’s lessons from 2015-16 – when sharp CNY depreciation expectations triggered large capital ouflows and downward pressure on FX reserves – and 2) the warnings from Washington.