Trade row's impact on growth declines

In light of the (temporary) ceasefire of the US-China trade conflict following the meeting between President Xi Jinping and his US counterpart Donald Trump on Dec 1, we at UBS now expect a less sharp slowdown in China's export and GDP growth in the first quarter of 2019. A mutual understanding of a stable RMB exchange rate is likely an important part of any trade deal, and as such, we expect to see the RMB to US dollar exchange rate hovering around 7 for longer. China's domestic policy mix may pivot somewhat as well.

We revise China's 2019 GDP growth forecast from 6.0 percent to 6.1 percent.

While we do not expect the two sides to reach a grand deal before March 2019, we think the probability of further delays in additional tariffs as the two sides negotiate beyond March 1 has significantly increased. As a result, the full year export growth will likely be slightly stronger than forecast earlier. Imports will also be slightly stronger than expected earlier, helped in part by expected additional tariff cuts.

Although the Dec 1 meeting held off further tariff increases for now to allow time for negotiations, risks of trade war escalation remain significant. That said, these probabilities may change drastically before March, as many factors, including US plan to restrict more tech exports to China and its actions against major Chinese tech companies, may complicate trade negotiations.

We expect more market reform and continued policy easing. Despite the better-than-expected outcome on Dec 1, we think China's existing and planned policy easing will continue to be implemented. The policy easing is partly an adjustment to earlier credit and quasi-fiscal tightening, and partly to offset trade headwinds. A delay in tariff increase (and potential easing of trade tension) will likely give the Chinese government some time to prepare for additional policy responses and reduce the urgency for a bigger stimulus.

We estimate the credit growth will rebound to about 11 percent in 2019 and infrastructure investment will grow by about 10 percent. More importantly, in accordance with China's long-term plan and as part of the trade negotiation, we think the Chinese government will tilt policies a bit more toward market reform in the annual Central Economic Work Conference and commemoration of the 40th anniversary of China's reform and opening-up. And additional corporate tax cuts and SOE reform measures may be taken, and the market could be further opened to private and foreign investors.

Although there were no reports on discussions about the RMB exchange rate during the Xi-Trump meeting, we believe a mutual understanding on the issue is likely an important part of any trade deal. As a result of delayed tariff increase, sentiment on the RMB has improved somewhat.

In 2019, disappearing external surplus (we now expect current account surplus to narrow from 0.4 percent of GDP in 2018 to 0.1 percent in 2019), shrinking China-US rate differential, and trade war-related concerns will likely put more depreciation pressure on the RMB. On the other hand, de-escalation of trade tensions and weakening of the US dollar will help support the RMB. As a result, we now expect the RMB to US dollar exchange rate to hover around 7 in 2019, before trading at about 7.2 at the end of 2020.

The author is head of Asian economic research and chief China economist with UBS. This is an excerpt from the 2019 outlook report of UBS.