In-Depth: A Checklist for China’s Economic Outlook in 2019

What will China’s economy look like in the year ahead?

The question is especially intriguing and complicated this year for the world’s second-largest economy after a rough year full of anxieties over slowing growth, financial risks and a damaging trade war.

Analysts have made gloomy forecasts that economic growth in China will slow to less than 6.5% in the coming year, the slowest since official data began more than two decades ago.

Troubles over the past year, from sliding investment at home to rising uncertainties abroad, will continue haunting China in the new year, said Bai Chongen, dean of the school of economic management at Tsinghua University.

The top leadership’s recent statement on next year’s policy priorities reflected analysts’ concerns. After the key Central Economic Work Conference (CEWC) to map out next year’s economic agenda ended Dec. 21, Beijing voiced “concerns amid changes” in the economic outlook and highlighted “downward pressure” in a “complicated and severe” external environment.

The biggest headwind for China’s economy could be the unsettled trade war with the United States, analysts said. The two countries agreed on a 90-day truce in early December, but whether a ceasefire will be hammered out depends on the negotiations.

The tariff fight since July between the world’s two biggest economies will clearly take a toll on China’s exports, and the damage will become more visible next year, analysts said.

China’s export growth will decline from 11% in 2018 to 5.6% next year, dragging down the country’s GDP growth by 0.8 percentage points, said Lu Ting, chief China economist at Nomura.

Escalating trade tensions have spurred a rush by traders to deliver goods as early as possible to avoid potential new tariffs, pushing up China’s 2018 exports, but the surge will not continue after March 2019, Lu said.

Wang Tao, chief China economist of UBS Investment Bank, predicted 4% growth for China’s exports in 2019.

“Slowing export growth, especially to the U.S., is likely to be the main factor hindering China’s growth in 2019,” Wang said.

At home, domestic engines to drive expansion also showed signs of weakening momentum, as growth in social consumption, fixed-asset investment and the property market slowed over the past year.

Uncertainties of the trade war will further hinder investments in export-related sectors, while the property market may risk a sharp decline after years of tightening control, putting China’s economy under greater pressure, analysts said.

What then can we expect from China’s policymakers to counter the headwinds?

The annual CEWC usually provides the most important clues for China’s policy agenda in the coming year. At this year’s conference, top leaders vowed to enhance “countercyclical” adjustments in macro policy in 2019 to alleviate pressure from the cooling economy.

The expression indicated that stabilizing growth will be the top policy priority for China in the coming year, Wang said. But the government will downplay the annual GDP goal and set a target range between 6% and 6.5%, she said.

Analysts predicted more-proactive fiscal policy, with a larger scale of tax and fee cuts and an increase in the issuance of special-purpose local government bonds to reduce the burden on business and support investment.

Policymakers will continue to fine-tune monetary policies to ensure increased credit supply to private and small businesses, said Zeng Gang, a banking expert at the Chinese Academy of Social Sciences.

Structural reform gained special attention at this year’s CEWC. The conference for the first time officially endorsed the principle of “competitive neutrality,” which has been seen as a tool to create a fair business environment for nongovernment enterprises and shake up the stodgy state-run sector. The conference also pledged to reduce the government’s meddling in business and further open up the economy.

Pushing forward structural reform is not only a long-term policy goal for China but also a key issue in trade negotiations with the U.S., Wang said. More policy efforts can be expected in 2019 to promote market reform, opening-up, SOE reform, intellectual property rights protection and private sector support, she said.

Changes are on the way. The day after the CEWC, a draft law on foreign investment was submitted to the national legislature. The proposal is seen as sending a strong signal of China’s determination to open up its markets and protect foreign investors’ interests, including articles to ensure equal treatment and market access for foreign investors as well as prohibit forced technology transfers.

As the new year countdown starts, here are some takeaways for China’s economy in the coming year.

Infrastructure investments will get more encouragement

Chinese authorities have shifted toward a pro-growth stance since late July with vows to step up infrastructure investment in key areas amid mounting concerns over the cooling of investment and business activity.

Government-led infrastructure spending growth slowed sharply in the first half of 2018, tumbling to 7.3% from 21.1% a year earlier and dragging fixed-asset investment growth to a record low.

With policies to expand local government bond issuance and ease borrowing controls on local government financing platforms, analysts expect to see a moderate rebound in infrastructure investment in the new year.

Increased spending on infrastructure is likely to widen China’s budget deficit next year, which has been held to no more than 3% of GDP for years. In 2018, the rate was set at 2.6%.

Many analysts have argued that China should allow its budget deficit to exceed 3% to allow for more-proactive fiscal policies in support of the economy such as tax cuts, especially under the current circumstance of slowing growth.

A major funding source will be special-purpose bonds issued by local governments, the proceeds of which will be earmarked for infrastructure and utility investments.

Jiang Chao, chief economist of Haitong Securities, estimated the issuance of such bonds will total 2 trillion yuan to 2.5 trillion yuan ($291 billion to $364 billion) in 2019, up from 1.35 trillion yuan in 2018.

UBS’s Wang said the government will soften its years-long control on local government fundraising through investment vehicles to allow qualified projects to accelerate in 2019. Wang predicted that infrastructure investment growth will rebound to more than 10% next year.

More tax cuts will be delivered

This year’s CEWC signaled that China’s implementation of proactive fiscal policy next year will shift from the previous focus on improving budget spending structure to greater tax cuts and increased local bond issuance.

A source close to the Ministry of Finance said the government is expected to cut a total of 1.5 trillion yuan from taxes and fees in 2019, compared with about 1.3 trillion of reductions this year.

China has lowered the VAT rate on the manufacturing sector to 16% from 17%, and the rate for other industries to 10% from 11%, starting May 1. But businesses are calling for deeper cuts.

An additional 1 percentage-point cut on the VAT rate for all sectors will reduce annual tax payments by 517 billion yuan, or 10% of the total 2017 VAT collection, according to Hu Jianyi, a professor at Shanghai University of Finance and Economics.

But as stricter enforcement of companies’ social security payments take effect Jan. 1, most companies are expected to see bigger bills to pay for their employees’ welfare, which they may have been avoiding up till now.

President Xi Jinping has pledged to reduce private companies’ social security burden by cutting their contribution rate and improving collection methods.

Tsinghua’s Bai said China is facing challenges to balance the business burden and widening pension shortfall, which will require a complex and deep reform of the country’s pension system.

Credit will flow to where it is needed

Analysts said liquidity in the banking system will remain ample in 2019 as authorities have signaled further monetary easing.

Wang projected that China’s 2019 credit growth will reach 10.5% to 11%, up from 9.6% in November. The central bank will further lower banks’ reserve requirement ratio and use various policy tools to manage market liquidity, but no interest rate cut is in sight, she said.

This year’s CEWC for the first time pledged to improve the monetary policy transmission mechanism to let credit to flow to the most needed areas of the economy, especially private and small businesses.

Regulators this year have taken more targeted measures, including bank reserve cuts and bond instruments to channel funds to private enterprises and small businesses.

The CEWC highlighted efforts to promote the development of private and rural banks so they can become alternative credit sources for small businesses.

Some analysts suggested that regulators should ease controls on certain shadow banking activities — the opaque, off-the-books lending that has come under scrutiny for helping local governments take on enormous implicit debts and for undermining stability in the financial system. Doing so could provide alternative funding sources for private business that have had difficulty obtaining loans from conventional banks, the analysts said.

Earlier in December, central bank Governor Yi Gang said that although “shadow banking” is a key area in which risks have accumulated, the term isn’t entirely “negative” because shadow banking can help supplement financial markets “as long as the operation is legitimate.”

CSC Financial Co. Ltd. said in a research note that the central bank will also roll out new equity financing tools to help the private sector expand fundraising channels and set up creative instruments to supplement bank liquidity, in a bid to expand the credit supply to the private sector.

Housing market faces tough test

China’s housing market is likely to have a hard year in 2019 as investment and sales are both expected to decline substantially, analysts said.

Lu predicted that housing sales in the first half may declined as much as 10% from 2018.

Nomura Securities forecast that China’s new home sales in 2019 will decline 4.6% year-on-year, compared with growth of 0.8% this year.

Since mid-December, several cities including Heze in Shandong province and Guangzhou in Guangdong have rolled back tough controls on local real estate markets, sparking speculation of a new round of deregulation after continued market tightening since 2016.

This year’s CEWC statement for the first time placed housing under a section about improving social security and people's well-being, instead of a separate section on the real estate industry as in the 2017 report. The change shows that the central government will take a more cautious approach on housing prices next year, according to the fixed income team at Citic Securities Co.

Analysts said they don’t expect a major turnaround of property industry policies as the government will continue reining in housing market speculation. But marginal changes are likely to be made to ease pressures on the industry.

Zhang Yu, an analyst at Huachuang Securities, said property industry policies will be more flexible in 2019 and will vary among regions.

That was echoed in a research report by Tianfeng Securities, which projected further easing in smaller cities but continued restrictions on big cities.

Sun Mingchun, chief economist at Deepwater Capital, said the current limits on developers’ fundraising are likely to be loosened to prevent a further slowdown of property market investment.

Long-expected legislation on property ownership tax, which is believed to be the best way to curb speculative purchase, will be submitted to the national legislature for review in 2019. But there is little possibility that the new legislation can be completed within the year, several taxation experts said.

Contact reporter Han Wei (weihan@caixin.com)