Crunch Time for China’s Economy

Is the trade war a ticking time bomb or an innocuous bluff?

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Courtesy of Financial Times

When China’s President Xi Jinping and U.S. President Donald Trump struck a 90-day trade war truce, different responses arose. Some saw it as a much-needed respite in the wake of a tumultuous year for trade multilateralism: the agglomeration of hostile protectionism was briefly halted. Others -- the majority, in fact -- believed the meeting signalled something more precarious in the all-mighty China’s economy.

China’s State Councillor Wang Yi sounded cautiously optimistic as he addressed the reporters after the conclusion of the high-stakes meeting. Cited from Reuters, he said that the significant joint-interests in the Sino-US relation implied “a greater need for cooperation than frictions.” Just 2 months earlier, Mr Yi traded barbs with US Secretary of State Mike Pompeo as he visited Beijing. In response to Trump administration’s scathing remarks on multiple issues, according to Nikkei Asian Review, Mr Yi accused the U.S. of “escalating trade friction” and “directly attacking the mutual trust in the China-U.S. relation.”

Hence, a striking turnaround from a government that rarely backtracked from their strong remarks was intriguing. As the truce expired next week, a question remains: was China really bruised by the trade war, or did it suffer from more structural problems?

Figure 1: Chinese trade figures significantly declined in November and December. Courtesy of Bloomberg

Trade data point the answer to the trade war

Throughout 2018, China’s trade data was better than what most people would have expected. Reported by Bloomberg, exports increased by 9.9% in dollar terms, pushing China’s trade surplus to USD 351.8 billion. Despite the decrement -- the figure stood at USD 422.4 billion in 2017 -- it still represented a respectable achievement considering the fractious trade environment.

The trade surplus with the U.S., in fact, widened by more than 17% year-on-year. The still-rosy outlooks of China’s data, for some people, implied that the United States was the one suffering more from the trade war. Various reports of American businesses flagging immediately surfaced several months after China slapped tariffs to American goods in retaliation -- American soybean farmers, for instance, were scrambling to find new buyers with some of them surviving on the government’s funding.

A detailed view, however, might suggest the opposite. As some economists previously pointed out, why did China show more urgency in hosting the Buenos Aires dinner when issues were not brewing?

The November and December trade data might just reflect the stinging effect hoped by the Trump administration. In November, China’s import and export performed way below analysts’ expectations in a Reuters poll. December was even worse: the trade figures contracted with regards to the previous year, recording the worst performance in 2 years (see figure 1 above).

Figure 2: Strenuous debts. Chinese non-financial corporates has accumulated a huge amount of liabilities and more loans started to falter. Courtesy of the Economist and CEIC

In the face of global economic gloom and increasing competition from the region, the situation is prone to unravel. The Economist reported that the corporate bond defaults topped USD18 billion in 2018 -- a stark increase compared to the previous annual record. CEIS data, meanwhile, showed that the non-performing loans performing ratio crept up from 1% in 2014 to almost 2% in 2018.

China’s debt-laden policies were superb in delivering instantaneous growth, but they established unwanted dependencies. China announced financial deleveraging measures in 2015, yet they put additional downward pressures to an economy already suffering from waning demand for its products: the GDP growth continued to plummet.

Debts were just a part of growing issues that might derail China’s ambitions. China’s one-child policy, originally aimed to curb population growth, starts to bite on the size of its productive workforce. The workforce itself is not particularly skilful. Despite the technological advancements it has produced, as reported by CSIS, China’s labour efficiency only ranks 38th globally. Its Asian neighbours with much-cheaper cost such as Vietnam are catching up fast -- both in terms of efficiency and prowess.

Government’s increasing influence in the private sector also has done little to minimise capital outflow. The red-tape bureaucracy and restrictive regulations to foreign entities (such as obliging them to partner with local companies) risk more foreign investments flowing out to its friendlier neighbours. These measures often produce unwanted repercussions, ranging from rampaging intellectual property theft to blatant intimidation of foreign businesses in the wake of diplomatic disputes.

Figure 3: Chinese private investments have substantially outpaced SOE's. Courtesy of Reserve Bank of Australia

The imbalanced treatment also plays a role; this time, in wooing away local investments. The state-owned enterprises, with its long-running inefficiencies, are shielded from the debt crackdown while the private companies are left exposed as revealed by South China Morning Post. When the state-owned enterprises prevail in almost every single occasion, no one could not really blame the private investors to channel their cash out of China.

Following the Central Bank’s of China to loosen the restrictions on outward foreign direct investment, Chinese companies started an investment spree overseas (see figure 3). Besides slowing down progress in improving domestic productivity, the channelling of money overseas exposes them to even-greater vulnerabilities. From foreign exchange to default risks -- most investments, predictably, are financed by debts -- the return of those investments are shadowed by foreseeable shocks.

Good deal needed

The trade war does not single-handedly jeopardise the world’s second-biggest economy. It, nevertheless, provided an additional punch that might have sent shivers to China’s high-ranking officials. With its biggest trading partner deliberately shunning its products, China was forced to return to stimulus-giving measures to kickstart the economy, elevating its risks and ultimately macroeconomic prudence. Disruptions in the supply chain, on the other hand, have damaged businesses’ confidence, with more companies start to look elsewhere to relocate their operations. In a country plagued by inequality and inadequately-trained workers, unemployment and eventually falling consumption lurk.

Striking a bad deal with the United States obviously is not the end of the world for China. China’s officials, nonetheless, are aware of the significance of having one. A good deal could have saved it from sinking while sailing through choppy times ahead. A bad deal might have just been the unwanted catalyst of its downward spiralling, dragging the world economy with it.

Works cited

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