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China’s economy: What’s behind the slowdown?

Is China’s economy slowing more rapidly than the country’s GDP data suggests? Our on-demand webinar with Fathom Consulting analyzed the current situation, including the U.S. trade dispute, the Belt and Road Initiative, and social unrest in Hong Kong.

  1. An on-demand webinar with Fathom Consulting has examined the Hong Kong and China economic outlook, including the impact of the U.S. trade dispute.
  2. China’s economy is slowing, with Fathom’s China Momentum Indicator showing the weakest reading since 2016.
  3. Strong data analysis is crucial to understanding China’s intricate and constantly changing economic outlook.

China’s economy is slowing from its frenetic pace of the past decade, with domestic as well as international repercussions.

The magnitude and reasons for its slowdown are the subject of debate, made more complicated by three diverse and intricate ongoing events that define China’s economy today.

China’s trade dispute with the U.S., continued international expansion via the Belt and Road Initiative (BRI) and troubling social unrest in Hong Kong are all factors for consideration when analyzing China’s current economic condition.

Fathom Consulting, a UK-based firm that has partnered with Refinitiv to produce high-quality chartbooks, recently hosted a webinar in which it pointed to its proprietary China Momentum Indicator 2.0 (CMI) as evidence of China’s slowdown.

The CMI slowed to a 4.2 percent rate of growth in August, which is the weakest reading since July 2016.

It shows that growth has been slowing since November 2017. The CMI, which combines ten indicators of economic activity, highlights the need for independent validation of China’s official national GDP data, which showed growth of six percent in Q3.

Fathom China Momentum and GDP.

Some market watchers argue that China’s slowdown is due to a strategic decision to rebalance its economy towards more consumer-driven growth, with less emphasis on exports and cheap credit, while the slowdown has also been exacerbated by trade tensions.

However, Fathom Consulting’s research did not show evidence of a growing consumer economy. The slowdown also precedes the trade tensions.

Erik Britton, CEO and Managing Director of Fathom Consulting, said: “If they were really rebalancing towards consumption you’d expect consumer imports as a percentage of total imports to rise, but in fact it has been falling for the last couple years.”

China’s economy and trade tensions

U.S. President Donald Trump began threatening tariffs on imports from China in March 2018. China has reacted in several ways, starting with a strategy of renminbi depreciation.

China has depreciated the renminbi by just over 12 percent, which nearly matches the effective value of the tariffs threatened and imposed on it.

If Trump goes through with his remaining tariff threats and China maintains this strategy, Fathom Consulting predicts that the renminbi will weaken to 7.7 to the dollar, from its current level of 7.0.

Joanna Davies, Senior Economist at Fathom Consulting, adds: “Every time that Donald Trump has threatened a tariff, China has fired a warning shot in the form of renminbi depreciation, and those depreciations are getting progressively larger.”

China has also increased its trade with markets such as Europe and Japan in order to offset losses in U.S. trade.

Another tool it has used is domestic subsidies to offset the impact of tariffs. Slightly more than one-third of state-owned companies are loss making, with many foreign-funded and private companies also making losses.

China loss-making industrial firms

“It’s telling that loss-making firms are managing to survive rather than going out of business as they would if they were not being subsidized and propped up by the government,” said Davies.

China has also undertaken targeted monetary easing to relieve high debt servicing costs.

A very noticeable measure has been to outsource manufacturing production to other countries in order to evade the tariffs, evident in the increase in overseas capital investments made by China. Vietnam and the rest of Southeast Asia have benefited greatly from this.

China has also cut its own tariffs on goods imported from other countries such as Canada to encourage alternative trade relationships.

Webinar participants were polled on the question: How would you describe Sino-US tensions?

A total of 40 percent of respondents said that the tensions are permanent, and they will remain at current levels, while 32 percent felt that the tensions are temporary and will reduce.

“We’re very much against the description of the trade tensions between the U.S. and China as a trade war. It’s not a war, because wars end, and we don’t see this ending anytime soon, irrespective of who is in office in the U.S.,” Britton said.

Belt and Road strategies

The Belt and Road Initiative is central to China’s foreign policy and economic expansion, and more countries, particularly in Africa and Latin America, are expected to join soon.

BRI investments have so far been focused on sectors strategic to China. Of the total investment, 38.7 percent has gone to mining, 35.9 percent to transport and 11.2 percent to real estate.

“The purpose of BRI is to locate the places where the commodities that China needs are found, and to transport those commodities to China, and then to transport the manufactured products that it produces out of China. Real estate is the infrastructure around those mining and transport links,” Britton said.

Injections of international investment have varying economic impacts, depending on the stage of development of the countries that receive them.

Poorer countries are often plagued by corruption, poor governance and weak infrastructure, resulting in a lower level of investment effectiveness.

Wealthy, developed countries have many potential sources of investment, so targeted schemes like the BRI have a limited impact. The biggest beneficiaries from BRI investment are middle-income countries, as they have the infrastructure to put the investment to work and the governance to ensure it is well used.

Existing BRI countries by income level

“China is focused much more heavily on poorer economies than it would make sense for it to be if all China was interested in was to have a maximum impact on the standard of living in the recipient economies. China has many other interests in play, such as maintaining supply of critical commodities into its own manufacturing process,” Britton said.

While some analysts have raised concerns that China faces risks if recipient countries are unable to repay their debts, Fathom Consulting research shows that if every BRI recipient were to default on its loans it would cause only a 6.3 percentage point increase in China’s debt-to-GDP ratio, a 0.1 percentage point drop in its GDP and a 0.2 percentage point increase in its 10-year government bond yields.

“These are risks that China can comfortably absorb,” Britton said.

Webinar participants were asked what impact the BRI would have on the Hong Kong economy, and an overwhelming 54 percent said it would have a minimal impact, with 36 percent predicting a moderate impact.

Social unrest in Hong Kong

Hong Kong, China’s premier international financial center, has been experiencing widespread social unrest since early June 2019.

The political crisis has pushed Hong Kong into recession, with the economy shrinking 3.2 percent in Q3, following a 0.4 percent decline in Q2. Analysts expect the negative economic impact to continue over the near term even as Hong Kong remains an important financial center.

Fathom's China Capital Outflows Tracker, M&A activity conducted via Hong Kong

Some analysts have pointed to the high cost of housing as one cause of the dissatisfaction of Hong Kong residents. On average, more than 60 percent of disposable income goes to rent, compared to just over 40 percent in Shanghai, with this being closer to 30 percent in other developed economies.

Housing costs are indeed very high in Hong Kong, but Fathom Consulting research shows other factors at play. When measuring key standards of the government’s effectiveness, regulatory quality, control of corruption, rule of law, and voice and accountability, Hong Kong consistently ranks above China and near the standards of the UK.

While this positioning has remained largely unchanged since Hong Kong’s handover to China in 1997, there are considerable fears that these standards will be eroded in the future, and Hong Kong standards will sink to China’s level, rather than China rising to match Hong Kong.

“It’s not just rent, it’s also fears about political freedoms and accountability that are at play,” Britton said. “The bigger question for investors is if, and how, China resolves the contradiction within one country, two systems.”

Webinar participants were asked to choose a word to describe their view of the economic outlook in Hong Kong given its current social unrest, and 53 percent chose “cautious”, while 42 percent chose the more serious response of “worried”.

Data-driven insights

China’s economic growth is slowing, and understanding the intricacies of the most dynamic economy in the world has never been harder. Strong data analysis plays a key role in understanding China and finding the true story behind the numbers.

The Chartbook, created by Fathom Consulting in partnership with Refinitiv, contains more than 9,000 charts covering more than 170 countries, including China, and it tells the macro and financial stories investors need to hear in order to make decisions with confidence.

Refinitiv has also recently completed its Datastream China Expansion, adding 320,000 new data measures across all China macro data sets.

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