Sino stimulus: How China’s hawkish policies will affect global markets

By Tom Wickers, Hottinger Investment Management

The US-China trade war has been a hot topic in daily news ever since President Trump first started applying tariffs on imports in 2018. The effects of these tariffs on the global economy are palpable, strangling growth in the United States, Asia and Europe alike. While many analysts are evaluating China’s trade policy to help forecast market conditions, there are few pieces dedicated to China’s fiscal and monetary policies and their significance to global growth.

On Friday, China released its Gross Domestic Product (GDP) growth data for the third quarter, disappointing analysts with a 30-year low figure of 6.0%. While some of the slow in growth is a consequence of its development into a richer society, this data has added its chime to a cacophony of alarm bells from other countries in recent months. China also announced an injection of RMB 200bn into its banking system last week, continuing the global trend of central banks reopening the taps on monetary policy stimulus. Earlier this year, China provided other injections and reduced taxes, but it is apparent that Chinese policymakers are refraining from reducing interest rates or implementing strong expansionary fiscal policy, contrasting with the aggressive rhetoric from other policymakers across the world. The key issue here is that whenever the global economy has flagged in recent years, it has been China that has dispersed funds internationally to reignite the growth engine.

There are several reasons why China is hesitant to utilise its economic tools. Perhaps the most significant is the dangerous level of debt the country has held preceding the current slowdown. Strong efforts to tackle both corporate and government debt have constrained leverage to a level that is closer to expected levels given its current economic fundamentals and growth. However, as the size of its leverage ratio was still substantial in Q2 at 249.5% of GDP[i], China’s policymakers will be averse to encouraging its lending system – particularly when considering they have only just regained control of debt levels. Figure 1 shows the Chinese credit gap; the difference in the leverage-to-GDP ratio from its long-run trend. History tells a dangerous tale for countries that have maintained a positive credit gap prior to shocks. The Spanish economy took a notably large hit from the Global Financial Crisis in 2008 and required a bailout in 2012. When Thailand unpegged the Thai baht from the US dollar in 1997, markets fled the currency and the Asian Financial Crisis ensued. Evaluating China’s leverage trend with reference to these historic cases and with consideration to the possibility of an impending global recession, it is unsurprising that it is unwilling to ramp up stimulus at this time.

Figure 1: Historic leverage-to-GDP ratio versus the long-run trend (%) – The long-run trend is shown by the dotted line and the difference between the solid and dotted lines represent the credit gap. The vertical black lines are when a shock occurred (or a bubble burst) and a crisis ensued

As mentioned, debt level is but one of the factors that compound Chinese reluctance to resort to stimulus. Inflation rates  hit a 5-year high in September, at 3.0% on the back of soaring pork prices[ii]. The Sichaun Development Guidance Fund has recently announced that it is running out of economically viable infrastructure projects for China, which have been a major channel for domestic stimulus. Funds directed this way would therefore be at risk of creating bad debt or losses[iii]. From a global perspective, China stands to benefit less from propping up global growth with cash and credit injections. The trade war with the US is hampering China’s export industry. The longer the disputes last, the greater China’s shift will be to other drivers of GDP, which will further reduce Chinese reliance on the health of international markets. Moreover, some aspects of the Chinese economy are still standing strong, such as the housing market. Until these start to deteriorate, China will likely still be pleased with its growth figures.

If China chooses not to fund global growth in difficult times ahead, as its current stance and the referenced data would suggest, a large funding hole would result and other countries would struggle to fill it – China’s GDP is the size of the 3rd-6th largest global economies combined. China has bankrolled global and US growth through credit and foreign investment in recent years. Any dip in growth has been met by further Chinese stimulus and the revival effects are evident [Figures 2 & 3]. A recent McKinsey study, looking into how exposed global trade, technology and capital are to the seven largest country economies, has corroborated this relationship[iv]. The world’s exposure to China has tripled in the past 20 years and is now greater than the average exposure to the other mega-economies. This is particularly stark given how separated some aspects of China’s economy are from the world; foreign ownership of Chinese capital is only 6%, for example. China’s exposure to the world, on the other hand, is 0.6x the average and has been decreasing.

Figure 2: China’s global credit stimulus – the left-hand axis relates to the JP Morgan index and the right-hand axis to China’s credit impulse

Figure 3: China’s investment stimulus – the left-hand axis relates to China’s Fixed Asset Investment growth and the right-hand axis relates to US GDP growth

Patience is a virtue and China historically has plenty. With the issues riddling the Chinese economy and limiting its ability to achieve more growth in healthy ways, it would seem prudent for world leaders not to expect financial aid from the East. In China’s wake, the funding gap needed to restart global growth, if it falters further, would be hard to meet and economies may find themselves in stagnation for longer than they would hope.

[i] https://www.chinadaily.com.cn/a/201909/02/WS5d6cb7cea310cf3e3556936c.html

[ii] https://tradingeconomics.com/china/inflation-cpi

[iii] https://www.ft.com/content/6aaa5bfe-efce-11e9-ad1e-4367d8281195

[iv] China and the World, McKinsey Global Institute, June 2019