China Heading Toward Sub-6 Percent Growth

Trade war is massive overhang on China's economic prospects

Workers pull a line from a cargo ship as it prepares to berth at a port in Qingdao, China, on Oct. 19, 2018. STR/AFP/Getty Images

News Analysis

China posted economic growth figures for the third quarter that were its worst in more than 30 years.

The official annualized growth rate of 6 percent came below consensus estimates, and if economists thought that was a terrible reading, what’s ahead may be even worse.

The result was certainly disappointing to economists, but it shouldn’t have been a surprise. On the one hand, China’s National Bureau of Statistics (NBS) couldn’t have released anything below 6 percent. Given that this month marked the 70th anniversary of Chinese Communist Party (CCP) rule over China, the optics would have been disastrous.

Meanwhile, anything above 6 percent would seem egregious, given the economic circumstances.

China continuing trade war with the United States has dented exports and investments in manufacturing. Auto sales are at decade-lows, falling 6.6 percent in September, and marking the 15th decline in 16 months. Overall fixed-asset investments—an important broad measure which includes local infrastructure spending—rose by 5.4 percent in September, slowing 0.1 percent compared to the previous month. It was the third straight month of declining growth.

Heading Below the ‘6 Percent’ Barrier

Economists know that the official NBS gross domestic product growth (GDP) figure is inflated. It always has been. Depending on who you ask, the real rate of expansion is likely somewhere in the minus 2 percent to plus 3 percent range. It almost doesn’t matter—changes in growth are mostly viewed relative to adjacent periods.

However, the reported growth rate has taken on a somewhat symbolic role, with 6 percent being a psychological threshold that, if breached, could trigger political embarrassment, mass investor selloff, and widespread consumer panic.

And Beijing is dangerously close to breaking that barrier.

“We continue to see risk of sub-6 percent growth in Q4,” Morgan Stanley analysts wrote in a downbeat note to clients Oct. 18. “Besides the filtering-through impact of September tariffs and overhang of tariff uncertainty, domestic property market activity could slow due to pass-through of tighter property-related policies in recent months, and consumption growth may remain subdued amid a weak job market.”

Even the ever-bullish International Monetary Fund (IMF) is predicting lower growth ahead for China. Its latest World Economic Outlook report from October predicts that China’s 2020 GDP growth rate will come in at 5.8 percent. That’s a sizable downward revision from its previous 2020 forecast of 6.1 percent earlier this year.

The IMF credited the impact of tariffs and generally weaker global demand for Chinese exports as reasons for the slower growth.

Tariffs are the single biggest overhang on the Chinese economy. The United States and China are drafting terms of a “phase 1” trade deal, but details are still unclear. For now, media reports, citing insider sources, say that China has asked for a pullback of all existing tariffs before it goes ahead and purchases more U.S. agricultural exports. Until there’s clarity around “phase 1” terms, which could inform the future direction of the trade war, tariffs will remain a dark cloud hanging over China’s prospects.

However, ING Group Greater China economist Iris Pang is revising her fourth-quarter GDP growth higher, to 6 percent from 5.8 percent. But ING’s revision is far from a ringing endorsement of China’s economic fundamentals. Pang expects Beijing to engage in massive monetary policy loosening in the fourth quarter, coupled with significant infrastructure spending by local governments to artificially prop up growth.

Employment Is Paramount

Beijing has been preparing its people—and the world—for lower nominal growth for years. But there’s one thing that’s sacrosanct to the CCP: employment.

To minimize social unrest and keep its grip on power, the CCP needs to keep its workers busy and their eyes on the financial prize. It’s the No. 1 reason that Beijing is likely to greenlight more infrastructure spending, while desiring to keep debt at manageable levels.

As of the beginning of October, China’s local governments have already used up their annual bond quotas for 2019. Such bonds are generally used to fund infrastructure projects. The Ministry of Finance announced earlier this month that 3.04 trillion yuan ($430 billion) of new bonds were issued this year through September, accounting for almost 99 percent of the total quota approved by the rubber-stamp legislature, the National People’s Congress, for 2019.

So far, China has doubled the value of large-scale infrastructure projects approved in 2019 compared to last year, according to data compiled by the South China Morning Post. And Beijing is considering pulling forward and borrowing from next year’s bond quotas to keep projects rolling for the rest of this year, the Wall Street Journal reported.

That’s a fairly undesirable solution to keep growth going. But consumers’ pocketbooks have been squeezed—the only economic readings that have gone up are consumer prices. China’s Consumer Price Index jumped 3 percent in September, reaching six-year highs. Soaring food prices are partially to blame, caused by widespread pork shortages due to an African swine fever epidemic. And housing prices nationally are up almost 10 percent on the year—a positive trend for investors and the upper middle class, but negative for recent graduates and the working class.

This is why China so desperately needs a trade truce. It needs to keep factories open and goods moving so infrastructure spending doesn’t have to bear the brunt of the growth burden.

Beijing knows that the country doesn’t need more bridges, tunnels, or highways. What it needs is more demand, domestically and internationally.