Predicting drags and drivers

China’s economy may face challenges in 2020, but still deliver on growth and financial stability

From 6.6 percent in 2018, China’s official real GDP growth slowed to 6 percent year-on-year in the third quarter of 2019, and it appears set to drop lower than that. We believe the worst is not yet over and 2020 could be yet another tough year.

In 2020, we think the policy space is limited for another large round of credit easing. Other than delivering on growth stability, maintaining financial stability will be a key task, as years of stimulus have finally started weighing on China’s financial sector.

We expect real GDP growth to slow to 5.7 percent in 2020. Based on growth data since 2011, China needs to deliver real GDP growth of around 6.2 percent in 2020 to fulfill its promise on doubling real GDP in the decade from 2011 to 2020. The recent 1.9 trillion yuan (US$270 billion) upward revision to nominal GDP in 2018 may allow China to set a lower target and still make good on that promise.

That said, China values growth stability, so we expect China to adjust its 2020 growth target to around 6 percent, and it may further lower the target to between 5.5 and 6 percent in 2021. On the demand side, we see both drags and drivers for China’s economy in 2020. We identify local governments, developers, manufacturers and banks as the main drags next year.

Local government revenues from land sales could contract by 15 percent in 2020 after likely growing by 7 percent in 2019, offsetting the expected rise in the issuance of local government special bond. As revenues from land sales are a major funding source for local governments’ spending on infrastructure investment, we expect infrastructure investment growth in 2020 to remain weak after only picking up to 3.3 percent year-on-year in October 2019 from 1.8 percent in 2018.

Property investment growth (net of land purchases) could peak soon and slow from an estimated 7 percent this year to 3.5 percent in 2020. The output growth of steel, cement and other construction materials could therefore drop next year.

In terms of the trade dispute with the United States, despite a possible “phase one” deal, markets are looking toward a less likely “phase two” trade deal in the near term, and the US-China trade tensions could escalate again in 2020, hitting China’s exports and manufacturing investment growth. In the first 10 months of this year, manufacturing investment growth slowed sharply to 2.6 percent year-on-year from 9.5 percent in 2018, and it could remain low next year.

The down cycle for the construction machinery sector will likely continue into 2020. In the previous cycle, the compound annual growth rate of excavator output volume was 27.8 percent in 2009 to 2011 thanks to the 4 trillion yuan stimulus package. But the high growth was followed by a CAGR of -18.6 percent over the subsequent four years of 2012 to 2015. We believe what happened to excavators in 2012 to 2015 could happen again in the next couple of years.

There might be a credit crunch in some low-tier cities after a property boom over the past four years. China has already arranged for the takeover of some banks this year, but we think it is only the beginning and expect worsening banking problems in an increasing number of low-tier cities next year.

The unwinding of peer-to-peer lending could be another drag, as outstanding P2P loans have already dropped from 1,051 billion yuan at the beginning of 2018 to 589 billion yuan in October 2019, and the downtrend continues.

Yet there are also some drivers for the economy in 2020, including home completions, home appliances, a low base for autos and 5G. Following the strong recovery in home construction in 2019, we expect growth of new home completions to jump from an estimated 1.5 percent in 2019 to 10 percent in 2020.

This high growth rate for home completions could boost demand for home decoration materials, home appliances and furniture. Auto demand could also be stabilized after sliding for more than two years. Lastly, though not necessarily commercially viable yet, China has decided to roll out 5G, boosting investment demand.

Due to various constraints, we believe China’s space for policy easing is much more limited than before, with rising CPI inflation driven by surging pork prices as a new constraint, so we do not expect China to launch yet another round of big credit easing. We expect some moderate credit easing in 2020 and believe China may have to ease some tightening measures on the property sector. We also expect China to push more spending on infrastructure, with a focus on large cities and city clusters, especially those in coastal regions.

On fiscal policy, we believe there is limited room for further tax cuts in 2020. To fill the gap in 2020, China will have to raise its target fiscal deficit ratio to around 3.0 percent of GDP in 2020 from 2.8 percent in 2019 and significantly raise the quota of net local government special bond issuance to about 3.4 trillion yuan from 2.15 trillion yuan in 2019.

On monetary policy, we expect the central bank to continue adding liquidity to the banking system in 2020, with a combination of high-profile reserve requirement ratio cuts and low-profile medium-term lending facilities, pledged supplementary lending, re-lending and re-discounting. Specifically, we expect there to be RRR cuts totaling 100 basis points in 2020.