China's economy slowed further in the second half of 2018, according to official statistics published on Jan. 21 but the figures are well manicured and present a misleadingly optimistic picture.
As with everything in China, there are nuances we should not overlook. Slower growth has been a feature for a decade -- the inevitable consequence of maturity and modernity. At 6.6% in 2018, the rate of economic growth is still relatively high by global standards.
Rebalancing is evident with the dependence on exports and investment declining and consumption accounting for about three quarters of gross domestic product growth last year, the second highest in the last decade. Meanwhile, services as a share of household consumption is rising and reached 44%, a further signal of rebalancing.
It should be noted, though, that rebalancing is happening in the context of slowing economic growth as investment activity, now down to 44% of GDP from a peak of 46%, falls back. No change is expected in this pattern.
However, official growth data are highly suspect because the time series lacks any semblance of volatility and cyclicality. The stability of the real GDP figures, adjusted for inflation, contrasts with significant swings in nominal GDP in which the deflator, the broadest inflation measure, dropped by 3 percentage points to 8% during the year. It is highly unusual, to say the least, for large swings in nominal GDP to occur when the real, inflation-adjusted, value slips almost imperceptibly.
Even this level of growth, though, doesn't really align well with bottom-up data in retailing, passenger and freight traffic, and electricity consumption. It would be surprising if growth late last year was much more than about 5% percent and it could easily have been a bit less.
China's economy may not have hit bottom just yet, and, using official data, could slip further toward the bottom of the government's 6-6.5% target range for this year. But the government is starting to pull out the stops to stabilize it in three ways so that by the second half of 2019, it may perk up a bit.
First, the trade war with the U.S. had only a minor impact on the economy in 2018, but President Donald Trump's tariff strategy for 2019 would, if implemented, have a much more significant impact on an economy that is already slowing.
It is strongly in China's interests to reach a deal to keep that protectionist strategy in the deep freeze. If trade alone were the issue, the deal would not be so elusive, especially if Trump wants to shout about success too. But on the deeper matter of industrial and technology policy, it is doubtful that meaningful resolution will occur, and so, to put it at its mildest, the tension over tariffs is likely to remain.
Second, the hit to the Chinese private sector's confidence and performance resulting from the Communist Party's backing for state sector enterprises and policies is being addressed to a degree. The People's Bank of China has made a lot of liquidity available to companies, the National Development Reform Commission is urging more lending to private companies, and the March 2019 National People's Congress is expected to approve tax cuts and other fiscally-supportive measures.
Third, the deleveraging campaign, in which formal monthly credit growth has slowed significantly, from over 15% in 2015-16 to just under 10% in December 2018, is being eased incrementally, and may well extend through the first half of 2019. The extent will depend on how far growth actually slows.
The big question is whether these measures will gain traction and restart economic expansion, or whether they might only stabilize the downturn for a while. The latter seems more likely, bearing in mind that China's cyclical slowdown in 2018-19 is simply an overlay on structural challenges for which the remedies lie elsewhere.
For example, in a thoughtful paper published late last year, Professor Xiang Songzuo of Renmin University explained that China's economic prospects would depend much more on comprehensive tax reform, and reform of state and Party governance by which he implied a shift in the balance of power, wealth and decision-making away from the party and state toward the private sector.
One of the key things to watch in the next year is the property sector, vital to China's middle class. Many indicators, such as transactions and prices, have been slackening in the last year, but developers seem to be confident that the rules will be relaxed soon as part of the official policy easing program.
Perhaps so. Yet this sector, which broadly accounts for about 12-13% of GDP, is a weather vane of economic confidence, needs to be monitored carefully. After all, the apartment vacancy rate is already over 20%.
Meanwhile, China's economic slowdown, and the consequences of the trade war are rippling out, especially through east and south east Asia. Japan, Korea, Taiwan and Indonesia have all seen exports slacken. The electronics trade in Thailand and Singapore has gone off the boil. If, as expected, there's no early relief from the colder economic winds in China, the region is expected to feel the chill. The situation is clearly not helped by the fact that U.S. growth is also being undermined not only by the fade in Trump's fiscal stimulus executed last year, but the protracted government shutdown, and to an extent, the trade war.
On the other side, a steadier U.S. dollar, and shaved expectations about U.S. interest rates rising have come at a good time for Asia. Perhaps by the second or third quarters, with at least a partial trade deal done if luck holds, a more stable Chinese economy will start to drive a mild pickup in the region.
In the end, a lot hangs on how the trade talks go, for if Trump's next planned tariffs come out of the deep-freeze after all, for whatever reason, the impact on economic confidence and on performance is likely to be significant. Especially given China's difficult domestic situation.
George Magnus is an associate at Oxford University's China Centre and at SOAS, and is the author of Red Flags: Why Xi's China is in Jeopardy (Yale).