Dong Chen
While a sharp deceleration of China’s growth to below 6% is not part of our core scenario in 2017, such a possibility cannot be ruled out as China faces increasing domestic and external headwinds.
The tremendous amount of debts that China has been accumulating since the global financial crisis remains China’s greatest near-term challenge. According to our estimate, China’s debt-to-GDP ratio had risen to 261% by Q3 2016, from 145% at the end of 2008. Almost half of these debts, or roughly Rmb86.8 trillion (USD12.6 trillion), are concentrated in the non-financial corporate sector, but the growth in indebtedness is faster in the financial and the household sectors. The rapid credit growth has been accompanied by various imbalances, including overcapacity in heavy industries, a property bubble and explosive growth in shadow banking.
The growth in Chinese indebtedness, 1996-Q3 2016
China’s policy makers have stepped up measures to contain the growing financial risks. The country’s top leadership recently set out prudent and neutral monetary policy guidelines for 2017, with curbs on financial risks and asset bubbles seen as a priority. In parallel, measures have been introduced to cool down the property market, and the People’s Bank of China (PBoC) has allowed the money market rate to rise to squeeze leverage in the bond market. In this context, the prospect of monetary easing by the PBoC in 2017 is slim.
Higher interest rates and slower credit growth will almost inevitably weigh on China’s growth in 2017. The property bubble, further inflated in 2016 as housing prices surged, will be increasingly hard to sustain as potential buyers remain on the sideline. A major correction in housing, not inconceivable in some Chinese cities, could be a serious drag on China’s growth in 2017 as property construction slows down. In the worst-case scenario, a collapse in property prices could even lead to a financial crisis, given property’s central role in credit creation in China.
The Trump headache
On the external front, China will likely face headwinds in 2017 due to the potential protectionist policies that the new Trump administration in the US could announce.
During his election campaign, Trump criticised China repeatedly, claiming its unfair trade policies were causing the loss of manufacturing jobs in the US. He has threatened to declare China a currency manipulator and to impose punitive tariffs on Chinese goods. Trump has nominated several key members to his administration well known for their negative views on China’s trade practices. Peter Navarro, for example, who is the author of the book ‘Death by China: How America Lost Its Manufacturing Base’, was appointed head of the White House National Trade Council. Robert Lighthizer, an experienced lawyer who for a long time represented the US steel industry in trade litigation (including many cases against China), was nominated to head the US Trade Representative Office. Given the protectionist bias of the Trump administration, we believe it is highly probable that the US will launch more anti-dumping cases against China and some China exports to the US may face steep tariffs.
In addition, Mr. Trump has signaled he may try to leverage sensitive issues such as Taiwan to force China to make more concessions on trade. His recent comments regarding Taiwan that challenge the ‘one-China’ policy signify a major deviation from the diplomatic framework established under the Nixon presidency over four decades ago. Changes on the diplomatic front could have a negative impact on trade relations between the US and China, and, if handled badly, could fuel a rise in geopolitical tensions as well.
Thanks to strong control over the financial system, we believe the Chinese authorities should be able to handle China’s debt problems in the near term, and the Trump administration may not implement all the protectionist policies threatened during the presidential election campaign due to political constraints. Yet we cannot dismiss the downside risks too lightly. We have to keep monitoring events in China and stand ready to position our portfolios as conditions dictate.
Dong Chen is senior Asia economist, Pictet Wealth Management
