September 23, 2019

China: Fiscal policy to buffer trade war losses

Highlights:

Considering the headwinds from the US-China trade war, slowing global growth, the repercussions of past regulatory tightening of the shadow banking sector as well as idiosyncratic risks, China growth looks set to soften further.
This puts Beijing’s economic policy into a dilemma. On the one hand, it wants to reach its growth target of 6%-6.5%. On the other hand, China broke up with previous credit-financed demand policy which led to a strong increase in nonfinancial sector debt to 256% of GDP (IMF estimate) and the need to de-risk the shadow banking sector.
Therefore, we expect economic policy to basically compensate for the loss in growth but refrains from “big-bang” packages. Assuming the trade war status quo to hold, we expect fiscal policy to substitute for about another 0.8 -1 pp (on top of the 2 pp of GDP package early 2019). We expect the PBoC to cut RRR by another 50 bps this year, followed by 100 bps in 2020. The PBoC recently reformed the Prime Loan rate which could ease by 50 bps.
While the CNY may depreciate further on market forces, the bar for a deliberate strong devaluation remains high.