Caixin View: Trade War to Test China’s Resolve on De-Risking
* Direct economic impact of trade war less important than its influence on de-risking progress
* Campaigns to reduce financial risks, local government debt may be weakened
Activity data for August painted a fairly negative picture of the Chinese economy. Year-on-year growth in infrastructure investment, which consists of spending on the construction of roads, railways and other public facilities, slowed to 4.2% for the first eight months of 2018 from 5.7% in the first seven months — the slowest growth in data going back to March 2014.
Although the official Manufacturing Purchasing Managers’ Index (PMI) for August inched up from a five-month low in July, the Caixin China General Manufacturing PMI reading fell for the third consecutive month and represented the slowest expansion since June 2017. The employment subindex of the Caixin PMI showed the steepest contraction in 13 months, indicating more companies were shedding workers than hiring.
The trade war with the U.S. is playing some role in the slowdown, mainly by reducing demand for exports. The official manufacturing PMI’s subindex for export orders fell further into contraction and dipped to a six-month low. In the equivalent Caixin manufacturing PMI subindex, export orders shrank for the fifth month in a row.
But we don’t think the direct economic impact of the dispute will be that significant in the long run. As former People’s Bank of China Governor Zhou Xiaochuan said earlier this month, government models to calculate the impact of the trade war showed it would have “less than half a percent impact” on the Chinese economy. Zhou pointed instead to market confidence as the biggest likely casualty of the trade war. “It’s suddenly a kind of panic, the contagion. This kind of thing is not very easy to analyze,” he said.
We are more worried about how the trade war might impact government sentiment and policy. Concerns generated by the trade war might affect long-term de-risking priorities such as cutting local government debt and cracking down on “shadow banking.” If there were no trade war, China’s growth would still be slowing. But we think the government’s motivation to push through policies to reduce systemic financial risks would be stronger, and markets would be more confident in its ability to shore up growth while doing so. The trade war has already hit the currency and stock markets, and this has helped push “stability” to the top of the government agenda. The July 31 Politburo meeting called for the country to maintain “stable employment, stable finance, stable trade, stable foreign investment, stable investment, and stable expectations.” But the problem is that seeking stability might entail pulling back on efforts to deal with systemic financial risks.
For example, last month, in a sign that China’s regulators were concerned that tough controls over shadow banking were exacerbating a slowdown in economic growth, the government told trust companies that they could carry out some kinds of channeling business if it served the real economy. Channeling has been a key target of the crackdown on shadow banking because it makes it hard for regulators to monitor who the real borrowers are, and enables banks to hide the extra risks they're exposed to. Also in August, China’s state planner gave the green light to an urban rail project in the northern city of Changchun, signalling a resumption of urban rail construction reviews that had been suspended for about a year due to local government debt concerns.
A key gauge of the government's determination to push through de-risking policies, rather than put them on hold, will be whether it waters down tighter regulation of local government financing that was released March this year in “Document No. 23." This document sent a clear warning to state-owned financial institutions to obey a ban on providing financing to local governments in any form other than buying their bonds. The government has been trying to shift local government funding away from murky financing vehicles and towards more transparent bond issuance. As well as bringing down infrastructure investment growth, as discussed above, this ban has hit many localities hard — for instance, Leiyang city government in Hunan province admitted in June that it was unable to pay May salaries to its employees as scheduled. So far, the government’s resolve seems firm, with dozens of officials punished for breaking the rules. But we'll be keeping a close eye on this particular effort to deal with one of the key sources of China’s systemic financial risks.
September 19: State Administration of Foreign Exchange releases Chinese banks’ foreign-exchange purchases and sales for clients in August
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