President Xi has emphasized the economy is being hit by external forces and needs measures to support growth. At the same time, the National Council has announced a stimulus package. But the amount of the stimulus is missing in the announcements. We estimate it at CNY9 to 10 trillion. We also weaken our yuan forecasts for 2019.
Xi highlights external forces as a drag on the economy
When President Xi emphasized external forces as being a hit to the economy, he was most likely referring to the bilateral trade war between China and the US. The nature of the trade war has become clearer over time: as a technology war (the US avoids using China's technology, and avoids technology being transferred to China), an investment war (US imposes penalties on Chinese tech company running in the US), and an additional geopolitical element (naval standoff in South China Sea and, and military sales to Taiwan).
Xi's message implies that the chances of getting a positive result from a trade negotiation between China and the US are small. That means that the possibility of the trade war escalating and continuing to drag on the Chinese economy is high.
Depending on infrastructure, again
That explains why, on the same day as Xi's comment, the National Council announced a stimulus package. Most of it concerns infrastructure investment.
Infrastructure should be the fastest way to boost economic growth. We categorize the package into three parts.
- The first part is hardware investment, which includes railways, highways, waterways and airports. These will increase the demand for building materials and labor. So even if the housing market continues to cool, building materials and labor could be diverted to infrastructure construction projects. These projects should have positive cash flow after completion, so the burden on fiscal support should be temporary. This seems to comfort the market in terms of the risk to local government finances.
- The second part is environmental protection. These projects include water management and pollution controls. We would describe these as the "software of the economy". It is uncertain to us how local governments could generate a future stream of revenue from these projects aimed at a clearer sky and cleaner air. But they are goals worth pursuing anyway.
- The third part is social benefits in the form of improving rural living, medical care and schooling. These again are the software of an economy. The benefits are a higher quality of the future labor force. But it is difficult to measure whether local governments will over-spend the money.
This needs a lot of money but how much?
The stimulus package does not contain any monetary values. But we expect the stimulus package to be comparable in size to the 2009 package. As GDP has more than doubled since that time, the stimulus amount will also increase. We believe the total package could be around CNY 9 to 10 trillion.
The National Council has requested local governments to issue bonds to finance the stimulus, and banks to lend to these projects. We expect some local governments will again rely on local government financial vehicles to fund some of the projects. And we expect banks will mainly lend to projects that are undertaken by state-owned enterprises. We believe that private enterprises may be involved in some of the smaller projects.
This announcement could increase the risk of higher non-performing loans or defaults in the future. But the authorities clearly believe that the more pressing need is for immediate stimulus now.
Revising yuan to be weaker in 2019
Last but not least, the government requests a pool of future infrastructure projects. This means the government is prepared to dig in for a longer-term fight in the trade war with the US. This also implies that the Chinese government might depend on investment to support the economy for a longer time.
Our GDP forecasts are still intact as we consider the government's fiscal stimulus sufficient to provide support as trade tension escalates. We project GDP growth at 6.3%YoY in 4Q18, 6.2%YoY in 1H19, and 6.3%YoY in 2H19.
But we do expect USDCNY to continue to weaken if the trade war continues. We are keeping our forecast of USDCNY and USDCNH at 7.0 by end of 2018, but have weakened the yuan pairs to 7.30 by end of 2019 (previously at 6.50).
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