2016 has been a year of surprises.
Brexit, Trump, the Western Bulldogs and Cronulla Sharks winning premierships along with the reemergence of Pauline Hanson as a political force in Australia just to name five.
However, among those and others, few surprises have been greater than the turnaround in the Chinese economy.
From fear to fabulous in the space of less than 12 months, a stark turnaround that few were predicting at the start of the year when persistent weakness in the yuan, a batch of dire economic data and signs of capital outflows reaped havoc on financial markets.
To many, the economic miracle was coming to an end.
Obviously that didn’t happen.
The government opened up the fiscal stimulus taps, new bank lending soared and restrictions on property purchases were relaxed, creating the conditions to fuel an economic rebound, albeit using the levers many perceive to be the “old” China growth model.
With recent economic data almost unilaterally topping expectations, it’s clear that it’s worked.
Compared to where it began the year, the Chinese economy is ending 2016 on a significantly firmer footing.
“While there have been some jitters over capital outflows recently, many now expect China’s economic growth rate to remain at or above current rates throughout next year,” said Julian Evans-Pritchard and Mark Williams, economists at Capital Economics, in a note released late last week.
“This view rests in part on the belief that policymakers will do all that they can to prevent a renewed slowdown ahead of the Party Congress late next year, which will see an important reshuffling of senior leadership roles.”
While an understandable view given the improvement in the Chinese economy this year and the desire for perceived economic strength before the Party Congress, Evans-Pritchard and Williams don’t believe that the good times will last, suggesting that they remain “unconvinced” that growth will continue at its current trajectory ahead of this event.
“While the statistics bureau will doubtless continue to publish GDP growth rates close to the official target, it will matter little to Party leaders whether growth is somewhat slower than today, as long as growth hasn’t visibly slumped,” they say.
This chart shows Capital Economics’ “China Activity Proxy” — an alternate measure of economic activity — compared to the official GDP growth rate released by China’s National Bureau of Statistics (NBS).
While there’s been a noticeable acceleration in the former, fitting with the clear improvement seen in recent data, the proxy measure has growth currently running at around 6%, below the 6.7% level reported by the government.
With the economy now growing at what they deem to be an above trend pace, Evans-Pritchard and Williams say that it would take massive further stimulus to keep it there in 2017.
They don’t believe that will eventuate, suggesting that both fiscal and monetary policy will be less supportive, leading to a slowdown in economic activity.
“No easing looks likely in the foreseeable future given that policymakers have shifted their immediate focus away from shoring up growth towards addressing credit risks,” the pair said in relation to the outlook for monetary policy.
And on the fiscal front, they say that while the government may set a higher budget deficit target of 3.5% of GDP for 2017, up from 3.0% this year, “this will reflect continued efforts to bring spending on-budget rather than signal a looser fiscal stance”.
According to the pair, this will be felt hardest in the China’s property sector — one of the pillars that the economic recovery has been built on in 2016 — creating a scenario where the sector could actually detract from growth next year.
“As property sales cool, developers are likely to pare back their expectations for future demand and slow the pace of project starts,” say Evans-Pritchard and Williams.
While this will see economic activity slow, in their opinion, they believe this will actually be beneficial in the long-run, seeing growth return to more sustainable levels that will help to reduce financial sector risks.
“The slowdown we are expecting does not constitute a ‘hard landing’,” they say.
“We doubt that policymakers will repeat the mistake of tightening fiscal policy by as much as they did in late-2014 and early-2015.
“Policymakers still have plenty of tools with which to shore up the economy and would not hesitate to deploy them if growth slowed abruptly.”
Evans-Pritchard and Williams expect growth will average around 5% next year based off their “China Activity Proxy”, down from the current rate of around 6%.
“This would still be a strong performance for a country at China’s income level,” they say.
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