OECD Economic Outlook, Volume 2019 Issue 1

China

Growth is projected to decline gradually in 2019-20 as the economy continues to rebalance. Signs of the slowdown include the weakening of private investment, in particular real estate investment. Housing investment will remain subdued following a series of measures to restrict demand and a deterioration in consumer confidence. Accelerating infrastructure investment will partly make up for that. Consumption will grow steadily on the back of strong growth of disposable incomes. Foreign trade flows will continue to lose momentum as trade tensions have escalated. The current account surplus is projected to turn into a small deficit because of buoyant outbound tourism spending and lower exports due to higher tariffs faced by Chinese exporters.

Monetary conditions had been tightened by the restrictions on shadow banking, but are now being eased somewhat to support economic activity. A broad-based cut in reserves that banks are required to hold with the central bank is supplemented by new targeted tools aiming to increase lending to small, micro and private companies. Perpetual bonds and central bank bill swaps were introduced in early 2019 to boost banks’ tier 1 capital. Thanks to a number of additional tax cuts, fiscal policy will remain supportive and hold up consumption amid deteriorating consumer confidence. Government-backed infrastructure stimulus has returned, with the special bond-issuance quota increased by ¾ per cent of GDP, boosting growth but risking the worsening of capital allocation efficiency. Implicit guarantees to state-owned enterprises and other government entities need to be gradually removed to sharpen risk perception. Eliminating restrictions on the entry and conduct of foreign firms is needed to continue to create a level playing field.

The economy shows some signs of weakening on the back of rising global uncertainties

Growth has weakened gradually amid ongoing trade tensions and global uncertainties. Domestic demand, in particular consumption, has remained robust thanks to steadily rising disposable incomes. Infrastructure investment has picked up on the back of the increase of the special bond quotas and the easing of rules for enterprise bond issuance. Business investment remains stable, in particular in services, as the economy continues to rebalance. Real estate investment, in contrast, remains weak, with new residential housing starts plummeting. Trade has weakened as the frontloading of exports has ended and the imports of capital goods have slowed amid rebalancing and gradual moving up the value chain. As tourism imports have remained robust, the current account surplus has declined.

Industrial production and external trade: China

1. Monthly industrial value added data for January and February are not published separately, but the two months combined. The missing data are computed by linear interpolation.

Source: CEIC.

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China: Demand, output and prices

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Shadow banking and investment: China

1. Core shadow banking items include entrusted loans, trusted loans and undiscounted bankers' acceptance.

Source: CEIC; and BIS.

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Monetary and fiscal policies will ease, but structural reforms should accelerate

Monetary policy was tightened somewhat over the past year by the restrictions put on shadow banking, which were necessary to maintain financial stability. The authorities exempted banks from tax liabilities related to their lending to smaller and private firms, which came on top of targeted reductions of reserve requirement ratios for banks directing a certain share of their lending to such firms. However, these measures were insufficient to solve the private sector credit crunch. As a new measure, banks are now encouraged to channel 30% of their new lending to the private sector. A large amount of bonds will mature this year, but the ensuing liquidity problems of local government investment vehicles will be eased through loans from the China Development Bank. The relaxation of enterprise bond issuance rules by the National Development and Reform Commission for top-rated firms last year will alleviate refinancing concerns for property firms as well. New credit risk mitigation tools will make bonds more attractive for investors. More stringent reporting and disclosure requirements would make it easier for smaller and private firms to get access to credit.

Fiscal stimulus will hold growth up but better pricing of risk is needed to reduce misallocation of capital. Removal of implicit guarantees to state-owned enterprises and other public entities would help, and the announcement last autumn to let ailing local government investment vehicles exit the market is a step in that direction. Special bond issuance quotas have been increased for 2019 by about 0.7% of GDP, though it is unclear how much of this local governments will be able to actually issue, given the weakening of land right sales, the proceeds of which are the major source of repayment of such bonds. The impact of tax cuts aimed at boosting consumption may be mitigated by adverse confidence effects. A minimum level of public services should be ensured through better allocation of resources to provide more equal opportunities to individuals regardless of their place of birth. Central funding for basic public services, such as education and health, is needed to ensure a sufficient level of service provision.

The recent approval of the new foreign investment law is a major step to ensure that China remains an attractive investment destination. In the longer term, steady inflows should continue as the current account is shifting to deficit and capital outflows intensify due to portfolio diversification by investors. In particular, imposing criminal penalties for the infringement of intellectual property rights is a positive development towards levelling the playing field. Checks and balances to ensure enforcement will be key to its impact.

Growth is projected to slow gradually, but remain robust

Growth is projected to slow further as the economy rebalances. Exports and imports will slow somewhat, the former as a result of the tariffs imposed last year, though a new round of import tariff cuts recently introduced by China, an increased VAT refund on exported products and a lowering of export taxes will mitigate the impact of trade tensions. Easing producer price inflation will also strengthen competitiveness and exports later on this year and in 2020. Consumer price inflation will nonetheless pick up somewhat due to higher fresh food prices, partly reflecting African swine fever, but these one‑off pressures will remain benign. Surging overseas tourism will push the current account balance into a slight deficit.

A major upside risk is alleviation of trade tensions, which would not only lift exports but also improve consumer confidence. Downside risks in addition to further escalation of trade tensions stem from financial conditions: reining in shadow banking enhances financial stability and transparency, but may cause funding difficulties by smaller firms, weighing on private investment. An acceleration in corporate deleveraging would help to restore balance sheets amid rising debt service costs, but would slow growth in the short term. The impact of tax cuts may be smaller than expected owing to subdued consumer confidence and the slow pace of structural reforms to boost consumption.