Can China’s policy makers really prevent the slowdown?

Fri 22 Feb 2019

Over the past few months, ‘trade-wars’ have moved from obscure historic reference into everyday jargon, casually dropped by consumers on sentiment surveys. The US, suffering from chronic trade deficits and increasing imbalances in its co-dependent relationship with China, has set its sights on trying to disrupt this process, a policy that has had an impact far and wide on various aspects of the Chinese economy.

In 2017, the US imported approximately $506bn worth of goods from China. On $53bn worth of these Chinese goods, tariffs were applied by the US in early 2018. In July 2018, the US imposed two further rounds of tariffs on Chinese goods, totalling more than $250bn on a wide range of industrial and consumer items – from handbags to railway equipment, and threatened additional tariffs on the remaining goods totalling $267bn. With tariffs on 50% of all Chinese imports already in place and the US being one of China’s major importers, the impact of these tariffs was bound to impact the Chinese economy. Since July last year, manufacturing activity, new orders, employment and even domestic demand has deteriorated in China. To provide support to the economy, the Chinese government announced a number of policy measures, including a mix of tax cuts and increased infrastructure spending.

The People’s Bank of China cut its Required Reserve Ratio (RRR), a move which the Chinese government tends to employ when concerned about growth prospects. The cut in RRR is intended to inject cash into the banking system by reducing the amount of cash that commercial banks have to hold as reserves. In theory, the reduction of this ratio helps to boost the money supply. Since Chinese commercial banks now have to maintain smaller reserves, they can now lend more money to consumers.

Over the past year, China has reduced its RRR five times. Notably, four out of these five times has been after trade talks between the US and China commenced. The chart above shows how Chinese equities have performed alongside the RRR cuts. One might notice that equities tend to rally for a short period after an RRR cut. Despite the cuts however, Chinese equities have been falling in price for over a year. The RRR cut in January 2019 released approximately £91.5 billion cash into the economy and led the way to strong equity gains, however, attractive valuations and currency trends are also factors driving Chinese stocks currently.

Despite the RRR cuts, worries surrounding the Chinese slowdown have not disappeared. To add to these worries, Apple Inc. announced a revenue warning last month, blaming economic weakness and lower demand in China for its shortfall. Apple suppliers have also cut their forecasts over the past few months due to volatile customer demands. Manufacturing activity in particular showed weaker sentiment in China. Over the past 2 months manufacturing PMI’s have been in contraction territory, signalling stalling growth in the sector. With China’s share of global GDP totalling 18% as of 2018, its slowdown in growth has a significant impact on overall global growth.

As China continues to deal with the effects of an economic slowdown domestically and a trade war with the United States externally, the RRR is likely to be a key element of its monetary policy this year. At the same time, China must try and avoid a repeat of its efforts in response to the global financial crisis of 2008. The fiscal and monetary policy loosening at the time led to a surge in risky lending and huge piles of government debt. At its annual conference last month, the PBOC announced that supporting growth while maintaining control over financial risks will remain its priority this year.

With the March 1 deadline to reach a trade deal edging closer, it is evident that China’s policymakers are concerned and do not want to misalign assets this time around. It will be interesting to see how policy changes affect a slowing economy like China’s, which has been growing rapidly for so long. With Chinese A shares gaining more weight in major indexes, investment managers will need to respond to these changes and consider adjusting strategic long term asset allocations for the huge role the Chinese economy and the Chinese consumer will play in the future for global growth.