China’s economy is probably growing more slowly than the government’s target rate in the final weeks of 2018, with recent efforts to support growth having failed. Conditions may get worse before they get better; a cooling housing market is only beginning to take its toll while investment growth is also set to slow again. 

Pressure to do more to boost the economy will increase, testing the leadership’s very public commitment to reining in credit excesses and delivering more equitable growth. 

Although the government’s focus is reportedly shifting back to advancing its reform agenda, particularly in the glare of the White House,  President Xi Jinping’s speech  on Tuesday — marking the 40th anniversary of China’s reform and opening up policy — was disappointingly light on the policy path forward. 

The economy appears to be growing below the 6.5 per cent target in the final quarter of the year, but a better than expected first-half performance means the goal is still achievable. Next year’s target, expected to be announced on March 5, may be lowered to a range of 6 to 6.5 per cent. Meeting it will prove challenging if credit growth continues to slow. 

Finance blocked

The flow of credit through shadow finance channels shrank again in November, resulting in the growth of system-wide finance falling to a new low. Bank loan growth has been largely stable over the past two years, though this means that traditional lenders have failed to compensate for the forced retreat of trust companies and other providers of off-balance-sheet loans. 

We have previously argued that the economy will  remain under pressure without a clear improvement in credit growth. The temptation to relax constraints on risky lending practices appears to be increasing as the government tries to boost infrastructure investment activity — which is mostly financed by this kind of lending — and as the housing market finally turns. The headline index of our  November real estate survey fell to its lowest level in almost two years as developers reported that prices dropped across all cities surveyed. Although a jump in new housing starts helped boost property investment growth in November, falling land and property sales will feed through to weaker investment in the coming months. 

This does not bode well for overall investment, which is still a key driver of Chinese growth. Better manufacturing investment growth helped push up overall investment growth, but manufacturing is reliant on the housing market and infrastructure, as well as exports, and the outlook for all three is uncertain at best. Unless the domestic finance and global trade pictures improve, a forward reading of property and infrastructure investment suggests manufacturing growth is set to weaken again. 

The deteriorating economic environment has rattled consumers. Alarmed at the fallout from the 2015 stock market collapse, the government encouraged households to borrow to buy apartments and egged on banks to lend to them. The result is record high levels of household debt, while consumer expectations for further house price gains are cooling sharply. Our monthly read of household sentiment recovered slightly in November following the sharp erosion of recent months, but slowing retail sales growth shows the susceptibility of consumer spending to falling asset prices and negative economic news. 

Managing the slowdown

Despite speculation about a major stimulus response to boost the economy, official rhetoric suggests the leadership is still wary of doing too much. The Communist party politburo last week highlighted the importance of its three “critical battles”: tackling financial risk, cleaning up the environment and alleviating poverty. 

The approach to these has been inconsistent. Beijing’s support for the economy has been blamed for the  rebound in global carbon emissions this year. On the other hand, determination to tackle financial risk has caused shadow banking to retreat and forced a slowdown in the property sector. Alongside its battles, the party highlighted the contradictory tasks of maintaining stability in six areas, including employment, finance and investment. 

The government accepts that the years of heady growth are over and is trying to manage the economy’s slowdown while keeping domestic conditions — the labour market in particular — under control. This prescribes a continuation of targeted, gradual policy easing rather than big-bang stimulus such as was seen during the global financial crisis. 

The government is reportedly preparing Rmb1.5tn ($218bn) in individual and corporate tax cuts, including lower value added tax rates ( but not vehicle purchase taxes, immediately). The reserve requirement ratio could also be cut again, following the four adjustments this year, to release more funding back into the economy. 

Easing measures such as these will not have the immediate economic impact of a state-engineered spending boom but will help keep risks in check and encourage a more balanced pace of economic growth. The problem is they may not be enough to counter the impact of a slowing housing market and still-tight credit conditions. 

This means Beijing will begin the new year with the challenge of keeping the economic engine on the track. 

— He Wei, financial researcher, FT Confidential Research

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and south-east Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.