On December 13th, the U.S. and China announced an agreement on a “Phase One trade deal”, which crucially prevented the next round of tariff increases which was scheduled for December 15th.
In addition, the U.S. has agreed to cut in half the tariffs that were implemented in September on $120 billion of Chinese imports. These developments are a positive for both for the U.S. and Chinese economies. However, this is not a comprehensive deal that deals with the toughest demands from the U.S. side, which aim at the heart of Chinese economy policy. As such, uncertainty around the trading relationship between the U.S. and China will linger next year and beyond. While the heat was not turned up further, the stove is not completely turned off, leaving the water simmering.Can the Chinese economy withstand the continued heat? Trade escalations over the past couple of years have negatively pressured the Chinese economy, causing a significant drop in Chinese exports to the U.S. and a deceleration in its manufacturing activity. However, the Chinese economy has not collapsed. Investment spending has contributed over 1% points to growth this year, while consumption has held up much better, contributing close to 4%. Independent business surveys, such as the Markit PMIs, confirm that a deceleration has taken place in manufacturing, but that services have held up significantly better.
In order to engineer this soft landing, the Chinese government has tapped on the accelerator multiple times over the past 18 months.
This has included monetary stimulus, but these have been very targeted measures given the Chinese government’s concern about the amount of leverage already present in its economy. Instead, the main focus has been on fiscal stimulus, including cuts to the value added tax, individual income taxes, and social security payments, as well as a push for infrastructure spending. Overall, we estimate that China has increased its deficit by over 2.5% points this year. These measures should offset the headwinds from trade, allowing the Chinese economy to move forward at a speed of a bit below 6% in 2020. The “Phase One deal” presents some upside risk; however, acceleration is not expected, given the Chinese government’s continued focus on high quality growth.Over the next decade, we expect Chinese growth to average 4.4%. A continued slowdown in China has been expected for a while, given its more mature phase of development and its worsening demographics. However, our expectation for long-term growth has come down from 5.0% last year, as a result of a less trade friendly future. It is crucial for investors to realize that 4.4% annual growth would be sufficient to more than double China’s GDP per capita over the next decade, bringing half a billion Chinese people into the global middle class. Trade-related headlines will likely be the new normal, but the Chinese consumer will remain one of the big structural growth themes for the next decade.
