13 JUL

2018

Macro , Topics

Is China vulnerable to a trade war?

Up to now, the authorities have kept a tight rein on their economy. Growth was still going strong at the start of the year (+6.8% yoy in Q1). Of course, the exacerbation of trade tensions could put the brakes on this momentum. For now, however, the magnitude of trade sanctions has proven limited: on 6 July, the US enforced a 25% hike in customs tariffs on $34 billion in Chinese imports (i.e. 0.3 GDP points) (chart 1). All in all, the Chinese economic environment should stay on track, all the more so since the authorities have already implemented measures to underpin activity (the reserve requirement ratio has been lowered twice year-to-date); if necessary, they won’t hesitate to use fiscal stimulus measures as well.

From a more structural standpoint, the authorities have succeeded in curbing the rise of private-sector debt (chart 2). Not only has the pace of mortgage lending slowed, but housing prices (which had climbed sharply in Tier 1 cities) have stabilised, and even begun to drop a little. Furthermore, over the last several quarters, non-financial corporate debt to GDP has stabilised. Lastly, the authorities have also managed to slow the development of shadow banking. Of course, the trade war and the price of the yuan are no less of a challenge for the authorities, and if tensions with the US grow worse, volatility on China’s financial markets could easily rise in their wake.

China’s balance of payments deficit could also put more downward pressure on the yuan. The balance of services deficit has been climbing steady since 2015 while the balance of goods surplus has fallen (chart 3), and despite enhanced capital control, capital outflows recorded in the “errors and omissions” column remain high (200 billion annual rate) (chart 4). More importantly, after falling in 2015, foreign‑currency corporate debt is on the rise again (chart 5).  If trade tensions intensify, downward pressure on the yuan could start up again (chart 6). On the plus side, the authorities still have a substantial amount of foreign exchange reserves and have so far proven that they can rein in capital outflows when necessary.