China - A Critical Global Growth Engine, Despite Deceleration

Despite U.S. trade wars, China will stick to its growth target and fiscal easing in the short-term, deleveraging in the medium-term and rebalancing in the long-term. That’s the message of Premier Li’s report.

Released on Monday at the annual session of the National People’s Congress (NPC), Premier Li Keqian’s annual work report sets the general tone for the 2019 economic policies.

In 2019, China has set a lower, flexible economic growth target at the range of 6.0% to 6.5%, while raising its tolerance of fiscal deficit at 2.8% of GDP.

The point about the GDP growth target is not how much it will exceed 6%, but that it should not fall below that level. That’s vital to sustain the quest to double living standard by 2020.

Tax cuts, 11 million new urban jobs

China is focused on raising per capita incomes, eradicating remaining poverty and battling climate change. Beijing is planning to cut $300 billion in taxes and corporate pension payments, especially to ease the burden on small-and- medium size (SME) enterprises.

The idea is also to cut the value-added tax rate that covers the manufacturing sector by 3 percentage points.

In this policy mix, the focus is on cutting banks’ reserve requirement ratios, instead of lowering interest rates, and guiding liquidity into SMEs. That supports the aim to create over 11 million new urban jobs.

Still, skeptical observers note that the purchasing managers index (PMI) came in at 49.2 in February representing the worst performance in three years. But the PMI data should be seen in historical context. A decade ago, when Chinese growth still relied mainly on manufacturing exports, PMI data reflected economic realities directly. As China is rebalancing away from manufacturing exports, PMI offers a less accurate picture of the full economy.

Indeed, the new Caixin PMI - which focuses on light industry, as opposed to the official survey’s focus on heavy industry - posted a sharp rebound in February, rising to 49.9 from 48.3 in January.

Foreign investment legislation and IPRs

In addition to Chinese growth, international observers are focusing on foreign direct investment (FDI) legislation and intellectual property rights (IPRs), largely due to U.S. trade wars.

In January, China’s exports rose 9.1% on year-to-year basis, up from -4.4% in December. China’s trade surplus with the U.S. remained high at $27.3 billion, due to sharp fall of imports and modest decline of exports. Unsurprisingly, the White House's punitive tariffs on Chinese exports have not resolved the issue of U.S. trade deficit. Bilateral tariffs against China simply cannot surpass these deficits that are multilateral and began already in the early 1970s.

When the U.S. and China began talks amid hopes for an agreement that would head off President Trump’s planned March 2 tariff increase on $200 billion in Chinese goods, China was already pushing plans to introduce a new foreign investment law. By mid-March, it is widely expected to replace three existing regulations and to increase IPR protection, while limiting technology transfer.

Yet, even a partial deal is unlikely to mitigate all broader tensions between the two nations on technology and industrial policy, as evidenced by the highly controversial extradition process of Huawei CFO Meng Wanzhou.

Instead of fair commercial competition - whether in 5G deployment or other areas - Washington is increasingly relying on contentious “national security concerns” to impair rival companies in China, Europe and elsewhere.

Turning financial tides

Recently, Chinese economic cooling has eased, thanks to early issuances of local governments’ special-purpose bonds and targeted adjustments to monetary policy, and increased infrastructure investment. In 2019, China plans to issue $320 billion of special local government bonds.

Since 2015, President Xi Jinping has promoted the idea of the supply-side reform to achieve greater policy focus on reducing industrial overcapacity and deleveraging the corporate sector. As the scope of supply-side reforms has now been broadened to include the financial sector, bank regulators are offering more diversified financial services, strengthening the monetary transmission channels and improving the efficiency of financial resources.

In 2019, China’s sovereign commercial debt could climb to $2.4 trillion, while local and regional government borrowing is expected to amount to $770 billion, according to Standard & Poor’s. But let’s put it in the context. In 2019 sovereign commercial debt will rise to $16.5 trillion in the U.S. and to $10 trillion in Japan.

Moreover, financial tides may be turning. Surging fund inflows indicate a rebound in sentiment for Chinese equities. While the market registered sharp inflows in 2018, nearly reversing prior years’ outflows, the Fed’s tightening seems to be peaking out.

Additionally, MSCI Inc. will quadruple the weight of Chinese stocks in its global benchmarks to 20%, which could translate to $80 billion of foreign inflows to China. Recently, China’s blue-chip CSI300 Index surged its best week since fall 2015. And the Shanghai Stock Exchange is in the final stages of launching a highly-anticipated Nasdaq-style high-tech board, which will serve as a financial incubator for innovative technology firms.

The valuation of Chinese market, as measured by CAPE (cyclically-adjusted price-to-earnings ratio) is still relatively low at 15, whereas the U.S. figure, despite recent losses, remains almost 31; twice its historical average. In financial markets, China has huge structural potential to expand, whereas the U.S. is hovering too close to a secular edge.

Gaining global approval

Despite deceleration, the size of Chinese economy has tripled in just a decade. Last year alone, China’s added GDP is equal to the value of Australia’s total output. As China’s contribution to the world GDP growth will continue to exceed 30%, it supports global economic prospects.

Chinese leadership’s commitment to more inclusive globalization remains strong, as President Xi Jinping affirmed in last December’s anniversary of reforms and opening-up policies.

China’s innovation is prominently displayed by world-class productivity in the Greater Bay Area of South China, and international cooperation by the One Road One Belt initiative that’s fueling 21st century globalization.

According to Gallup’s new Rating World Leaders, U.S. leadership approval ratings have plunged, while China's leadership is gaining more clout.

Irrespective of Washington’s trade wars, Chinese reforms will prevail.