IMF Sees No Reasons For China’s Economy Not To Stop Slowing

A chart showing China's slowing GDP growth trajectory, 2010-2024. Source: IMF, Bystander Media

The IMF’s CHANGE in its forecasts for China’s growth this year and next go in opposite directions to those for the global economy as a whole.

In the new edition of its World Economic Outlook, The Fund projects 6.3% GDP growth this year and 6.1% in 2020. That is a one-tenth of a percentage point increase and reduction respectively on the Fund’s forecast in January, which in turn was unchanged from its forecast last October. However, for the world economy, it has cut its projections for this year but sees faster expansion in 2020.

The upgrade to the China forecast for this year is in large part technical. The Fund has dropped the assumption made in its previous forecast that the US tariff rate on $200-billion worth of trade would rise as threatened by the Trump administration to 25% from 10%.

China’s growth had started slowing in the second half of 2018 as a result of the measures to deleverage and rein in shadow banking, and the increase in trade tensions with the United States. At the same time, the consequent slower domestic investment was accompanied by softening consumption, particularly for cars, whose sales declined with the ending of incentive programs. The economy expanded by 6.8% in the first half of 2018, but by only 6.0% in the second.

For this year, the Fund expects economic conditions to improve as stimulus kicks in. Nonetheless, the external environment will be challenging: the advanced economies are slowing down; trade tensions with the United States are likely to persist regardless of any deal being struck in the near future, and there is likely to be a gradual tightening of financial conditions consistent with some further removal of monetary policy accommodation by the US Federal Reserve.

Even assuming no further increase in tariffs and a continuation of fiscal stimulus by Beijing, China’s economic growth is projected to slow this year and into next as the underlying forces that slowed growth in the second half of last year persist.

Longer term, the Fund sees a gradual slowing of the economy to 5.5% annual GDP growth by 2024. This is assuming the successful continuation of rebalancing towards a private-consumption and services-based economy and of the authorities’ actions to slow the accumulation of debt and mitigate its associated vulnerabilities.

This Bystander has less confidence in the second assumption than in the first. Cuts to personal income tax and value-added tax for small and medium enterprises should help stimulate domestic consumption. However, authorities also eased back on deleveraging and injected liquidity through
cuts in bank reserve requirements.

Any excessive stimulus to support near-term growth through a loosening of credit standards or a resurgence of shadow banking activity and off-budget infrastructure spending would heighten financial vulnerabilities — another reason that President Xi Jinping may be anxious to secure a deal with US President Donald Trump sooner rather than later.

If no deal is reached with the United States, that will cast a dark shadow over the medium-term outlook.

The Fund acknowledges that some centrally financed on-budget fiscal expansion in 2019 may be appropriate to avoid a sharp near-term growth slowdown that could derail the overarching reform agenda. However, it says this should avoid large-scale infrastructure stimulus and instead “emphasize targeted transfers to low-income households so as to lower poverty and inequality”.

It also lays out its familiar shopping lists of structural reforms:

Reducing leverage in the economy will require:
⁃ continued scaling back of widespread implicit guarantees on debt;
⁃ early recognition and disposal of distressed assets; and
⁃ fostering more market-based credit allocation that better aligns risk-adjusted returns with borrowing costs.
Continued rebalancing will require:
⁃ a more progressive tax code;
⁃ higher spending on health, education, and social transfers; and
⁃ reduced barriers to labour mobility.
Enhancing productivity growth will require:
⁃ reducing the footprint of state-owned enterprises; and
⁃ further lowering barriers to entry in certain sectors, such as telecommunications and banking.

As an endnote, the World Economic Outlook devotes a whole chapter to the link between bilateral trade tariffs and trade imbalances, and questions whether bilateral trade imbalances can (or should) be addressed using bilateral trade measures. Its conclusion is a rebuff to US President Donald Trump’s stated intention of using tariffs to cut the US trade deficit with China. It concludes that:

Targeting bilateral trade balances will likely only lead to trade diversion, with limited impact on country-level balances. The findings of this chapter help explain why, despite the tariff measures, the US trade deficit is the largest it has been since 2008. The chapter also establishes that the negative impact of tariffs on output is significantly higher today than in 1995 owing to the bigger role of global supply chains in world trade.

The paradox is that Trump’s tariffs will not achieve their stated aim of achieving balanced trade and have imposed a cost on US manufacturers and farmers, bu have got Beijing to the table to negotiate over structural reforms to its development model that it has never been prepared to talk about before.

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US-China Trade Talk Progress Seems Real If Ill-Defined

VICE-PREMIER LIU HE will be back in Washington next week for a further round of trade talks with the United States.

This follows a lightning round in Beijing on Thursday and Friday with US Treasury Secretary Steven Mnuchin and Trade Representative Robert Lighthizer. Afterwards, both sides talked up the progress made particularly, it is widely reported, over ‘forced technology transfer’, the requirement for foreign investors to yield intellectual property in return for market access.

There is still no official word on the chapter and verse of this progress, and the use of words such as ‘constructive ‘and ‘candid’ to describe the talks suggest significant sticking points remain, particularly over enforcement mechanisms, as we have noted before in regard to China’s proposed new foreign investment law. So this Bystander will reserve judgment for now.

Regardless, it does seem that Beijing is engaging with the issue to a degree that it has not before. Its old argument that there was nothing to talk about as forced technology transfer did not happen, has been abandoned for the threadbare nonsense that it always was.

The outstanding questions now are to what extent will Washington gloss over some of the unresolved matters and how far it will be prepared to go in making concessions that will let China’s top leadership not lose face domestically.

There will also need to be a close reading of the Chinese- and English-language versions of whatever final text of a deal is agreed for each of the six areas of discussion: forced technology transfer and cyber theft; intellectual property rights; services; currency; agriculture and non-tariff barriers to trade. Many a slip…

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China’s New Foreign Investment Law Ready-Made For A Trade Deal

THE NEW INWARD foreign direct investment law, rushed forward and freshly rubber-stamped by the National People’s Congress, ticks all the boxes that Washington would want to see ticked.

But then it has been framed to do just that.

It overtly levels the playing field between foreign and Chinese companies in that it forbids forced technology transfer as a condition of foreign investment approval and makes it a criminal offence for officials to share foreign investors’ commercially sensitive information with Chinese firms (furnishing that information remains mandatory for local subsidiaries of international firms, however). Intellectual property protection is high on the list of US negotiators’ demands in the current round of US-China trade talks.

It also holds out an olive branch on another of their demands, greater market access, by adopting a ‘negative list’ system. Any sector not explicitly restricted will be open to foreign investors. However, there will still be 48 sectors that will remain off-limits, such as gene research, religious education and news media, or only conditionally accessible, such as oil and gas exploitation, nuclear power and airlines.

Regardless, both aspects can be packaged up to mutual advantage, a ‘win’ for the US side and a ‘concession’ by the Chinese one, though in truth they are neither.

When the new law comes into force on January 1, 2020, as with all Chinese legislation, it will provide a framework that will be open to interpretation and subject to enabling rules and regulations and the rigidity and frequency with which it is implemented.

Enforcement and redress via the courts is another matter. The judiciary is subordinate to the Party. Courts, particularly the new specialist business courts have due process, but also know their place. Every foreign firm investing and operating in China needs to appreciate that, and the difference between rule of law and rule by law. China has the latter.

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Options Narrow For A China-US Trade Deal

SUMMITS ARE FOR signings. US President Donald Trump’s second summit meeting with North Korean Leader Kim Jong-un in Hanoi should never have taken place. Or at least not until after officials had worked out what the agreement between the two countries was going to be. President Xi Jinping is not prepared to put himself at risk of the sort of fall-out that followed Trump walking out on Kim and that summit ending prematurely with no agreement.

The presidents meeting at Trump’s Florida resort Mar-a-Lago pencilled in for the end of this month to sign-off on a China-US trade agreement remains no firmer that, with Terry Branstad, the US ambassador in Beijing confirming to the Wall Street Journal that a date had not been finalised. The boosterish talk a couple of weeks back that a deal was near enough to completion to suspend the introduction on March 1st of 25% US tariffs on $200-billion-worth of Chinese exports is heard no more.

The sticking points of the agreement are proving as intractable as this Bystander has suspected all along that they would be, particularly over state subsidies, market access and forced technology transfers. No country readily changes its economic development model without either good cause or great pressure.

However, even the mechanism for monitoring and enforcing an agreed timetable for China to remove tariffs is proving difficult to nail down, as is getting the US side to agree to a schedule to withdraw its tariffs. The enforcement mechanism must be “two way, fair and equal,” Vice Commerce Minister Wang Shouwen said this weekend.

The US president is pushing for an early conclusion to a deal for political reasons. He needs demonstrable benefits from it to take into his 2020 re-election campaign. Xi also needs a deal that avoids him looking as if he has come off second best to the United States or has done anything to exacerbate the current slowdown in the economy.

For both, a narrow trade deal with enforcement mechanisms around only tariff-removal regimes seems more and more likely. Beyond that, Beijing will agree to buy more US produce and industrial goods and codify economic reforms that it is already planning to introduce. The more significant structural issues will be kicked down the road.

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US-China Trade Dispute Moves From Technical To Political Phase

US PRESIDENT DONALD TRUMP has extended the March 1 deadline for raising tariffs on $200 billion of Chinese imports pending a summit meeting with President Xi Jinping in Florida probably in the second half of next month.

Trump tweeted that ‘substantial’ progress had been made in the high-level trade talks between the two countries.

State media have used the same description of the progress.

The negotiating teams have been working on the text of an agreement that will cover currency, cyber theft and forced technology transfers, services, agriculture, intellectual property and non-tariff barriers. These texts will provide the framework for what state media call ‘the next phase’ of discussions.

There is no official readout from either side of what that progress is but it is thought to have been greatest over the yuan-dollar rate, technology transfer, intellectual property protection and non-tariff barriers — all areas in which Beijing has already been moving in support of its long-term economic reforms to rebalance the economy. China will also be making some immediate large purchases of US goods and produce to cut its headline trade deficit with the United States.

The sticking points are likely to remain subsidies and other supports to state-owned companies, which go to the heart of China’s economic development model.

Until the finalised texts can be seen, it will be impossible to judge what ‘substantial progress’ means, what the pace and scope of it will be, what remains unsettled and what mechanisms will be put in place to monitor and enforce whatever is agreed.

The US team will make one more visit to China for further discussions on that. The fact that Xi is going to meet Trump in Florida in late March rather than on Hainan Island immediately after the Trump-Kim Jong-un summit is a sign of how much of a gap there is between the two sides still, and how little Beijing has conceded on that score.

There is also the little-mentioned question of what concessions will be expected of the United States.

For now, however, it will be all about appearances and how the two presidents control the ‘optics’ of an agreement, which both men need to appear to domestic constituencies as a ‘win-lose’ deal more than a ‘win-win’ one.

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US-China Trade Deal: The Devil Is In The Enforcement

BEIJING AND WASHINGTON are both talking up progress by their trade negotiators as they each look to come up with a formula for avoiding the damaging consequences of the imposition of tariffs on US-China trade that will otherwise occur at the end of next week.

News that the Chinese team led by Vice-Premier Liu He will be extending this week’s two-days of talks in Washington can be read either way: that agreement is nearing and just needs a final push; or that it remains elusively far away.

On one superficial level, this Bystander believes, it is the former, but deeper down it remains the latter.

What is likely to be agreed by March 1, the deadline to conclude an agreement set by Presidents Xi Jinping and Donald Trump over dinner at last autumn’s G20 meeting in Buenos Aires, is a framework for further talks with six tracks: currency, cyber theft and forced technology transfers, services, agriculture, intellectual property and non-tariff barriers.

Each track would have binding objectives in terms of structural economic change in China. In addition, there would be an agreement to cut China’s bilateral merchandise trade surplus with a number of immediate big-ticket buys of US goods and produce, notably soybeans, which had been a $12 billion a year sale for US farmers before the tariff tit-for-tat started. Energy and industrial goods will also be on China’s shopping list.

The sections in the agreement for the six tracks would have been called memoranda of understanding in the old diplomatic language. Donald Trump does not like the term, and slapped down the US Trade Representative Robert Lighthizer for using it. Trump is a ‘dealmaker’, not a memorandum of understanding sort of guy; and to be fair to the president, touting that he has secured the ‘greatest memorandum of understanding  — ever’ just does not have the same ring as being able to boast of the making the ‘greatest deal — ever’.

Trump’s intent is to tie the big red bow on a deal at a meeting with Xi sometime after his summit with North Korean leader Kim Jong Un in Hanoi on Wednesday.

The six areas are all ones in which Beijing will be prepared to agree binding objectives. They are aligned with the structural changes it anyway needs to make to rebalance the economy. The sticking points are how far and how fast Beijing is prepared to go at this point, and, crucially, what monitoring and enforcement mechanisms it is prepared to accept.

Each of the six tracks has obstacles of differing degrees of difficulty to overcome. The currency one has already reportedly been settled. It was probably the easiest to tackle, given that China has a managed float for its currency in place and the yuan-dollar rate provides a clear and transparent measure, even if there is plenty of scope for argument over what constitutes a ‘fair-value’ rate.

On the other five, finding the right language that meets the Trump administration’s tough demands for structural change yet gives Beijing the room to soft-peddle has been proving as difficult as would have been expected.

The most progress has been made on intellectual property rights and improved market access; the least, on the role and practices of state-owned enterprises, subsidies, forced technology transfers from US companies operating in China and, thorniest of all, cyber theft of US trade secrets.

That last one goes to the heart of the issues between the two sides. If China is to succeed in ‘catching up’ with the US economy industrially and rebalancing its economy so the next phase of growth is driven by high-value manufacturing and services based on the next generation of industries, then it will need to acquire the technology to do so by fair means or foul and nurture the national champions to develop and exploit it.

Those priorities will not be given up lightly.

For Trump, a big political win on China, one of his core issues in the 2016 presidential election campaign, is essential going into his 2020 re-election bid. With the newly energised Democrats snapping at his heels, he needs headline concessions that sound grand and victorious to his electoral base, especially in the tightly contested states of the (formerly) industrial MidWest.

Xi, too, needs to demonstrate domestically that he has got the measure of Trump and that he is not yielding any sovereignty to Washington over the reform process. Any sign of the latter will be seized upon by his political critics.

So for both men, perceptions at home are critical. That is what an agreement at or around the end of the month will deliver above all.

Negotiating the details of implementation of what is agreed will take far longer. China will drag its feet on that to the extent that it can get away it until if and when US attention switches elsewhere whether under the current president or his eventual successor. Even a two-term Trump would be out of office ahead of the delivery year for Made in China 2025.

For that reason, this Bystander will be reading closely the details of the enforcement and monitoring procedures that are agreed.

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Interest Rate Liberalisation Is Key To Making RRR Cuts Effective

THE PEOPLE’S BANK of China has reduced the amount of capital banks need hold in reserve against bad loans for the second time in ten days. The required reserve ratio (RRR) has again been cut by one-half of a percentage point, with the central banks’ governor, Yi Gang, hinting there could be further cuts to come.

The two-phase cut on January 15 and 25 had been announced on January 4, when the RRR stood at 14.5% for large banks and 12.5% for smaller ones. It is the fourth cut in the RRR in a year, lowering the large banks’ RRR from 17%. The central bank estimates that the latest cuts will free up about 800 billion yuan ($115 billion) for new lending. 

The easing of monetary policy in this way is part of authorities’ moves to increase commercial banks’ lending to the private sector as a way of stimulating a decelerating economy while not easing up too much on the campaign to deleverage it that has been underway since 2017.

Providing the banks can pass it on to borrowers, particularly the in the private sector. In tandem, the finance ministry is instituting massive tax cuts to stimulate consumption and thus drive demand for the loans — cuts of 2 trillion yuan this year, up from 1.3 trillion in 2018, which will be matched by a similar increase in off-budget bond issuance by local authorities.

Private company borrowers have in the past had to rely on the shadow banking system because the big state-owned banks have largely shunned them. The crackdown on the shadow banking system to tackle the country’s debt problem has dampened shadow banking lending but not necessarily switched it all to the formal system.

The difficulty of the balancing act involved in cracking down on the shadow banking system without cutting off credit expansion is that after more than a year of the campaign, the debt-to-GDP ratio although decelerating was still 253% last June, according to Bank for International Settlements, the central banks’ central bank, against 231% at the end of 2015.

Progress in being made, however. Last month, the expansion of total social financing, the broad gauge of aggregate credit, at 9.8%, was lower than overall bank lending, indicating that lending is switching back to the banks, but the sag in fixed-asset investment last year suggests that unmet demand for credit is still there.

Authorities are guiding the policy banks to step up their lending to smaller private firms, not just their traditional customers, state-owned enterprises. This will continue, but the reform that is needed to make that effective is the further liberalisation of interest rates so banks can better price the risk of loans to private businesses, rather than just follow the central bank’s rate sheet.

Until that happens, regulators are in the contradictory position of wanting banks to increase their lending to inherently risky small businesses while at the same time lowering the overall levels of risks in their loan books.

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