Escalation of the US-China trade war could shave 0.7 to 0.8 percentage points off China’s GDP growth in 2019 when Beijing’s de-leveraging measures have already reduced credit growth to a record low. But Beijing can counter these headwinds.
After several rounds of monetary easing, expansionary fiscal policy holds the key to supporting China’s economy in 2019. We see policy shifting to tax cuts besides easier credit for private firms and a rebound in infrastructure spending, combined with reforms of state-owned enterprises.
Tax on Chinese companies’ profits equals 67%. Reforms in 2018 included lowering firms’ social-security costs, increasing tax-free income thresholds and allowing additional deductions. Some Value Added Tax rates were reduced marginally, but although VAT raises a third of government revenues, the state finances are strong enough to cut further.
Halving VAT on agriculture and services to 5% and cutting the manufacturing rate from 16% to 15% would cost the equivalent of 0.9% of GDP.
However, as manufacturing accounts for two-thirds of VAT payments, cutting that sector’s rate to 13% would be equivalent to 1.4% of GDP with more evenly distributed benefits. Slashing the rate to 10% and lowering the service-sector rate could produce a 1.6% GDP effect, further redistributing resources from government to the private sector.
Beijing’s budget-deficit target of 3% of GDP could be maintained by drawing fiscal deposits or cutting spending. But lower VAT should boost both consumption and corporate investment, with firms investing in technologies that help them stay competitive.
China’s economy is now 78% driven by domestic factors, compared with 45% in 2007. That lifts the multiplier effect because there are fewer leakages.
Although Beijing’s de-leveraging policy is not aimed at the private companies – which account for just 30% of corporate debt but 86% of employment and 70% investment – they are nevertheless impacted as banks shrink their balance sheets. With lenders preferring state enterprises – still seen as safer – private companies turn to costlier venture-capital financing.
To mitigate this, the central bank has eased monetary policies and provided some funds for the private sector. There have also been proposals for lenders to allocate quotas for business.
Infrastructure investment growth slowed from 17% to just 3% in 2018 following tougher regulations on public-private partnerships and shadow-banking. However, relaxing the policy has seen a sharp rebound.
Housing policies are likely to change in 2019 too. Monetization of the central-bank loans financing shanty-town renovation projects accounted for 15% of national housing sales in 2017, mostly in China’s third- and fourth-tier cities. Ending the programme should slow price rises, stabilising the market.
Meanwhile Beijing is promoting a new concept of ‘competitive neutrality’ that levels the playing field between state-owned and private businesses. This means reforming corporate governance to separate government from the enterprise, making subsidies transparent, and demanding equal returns from the two sectors while imposing similar tax, supervision and procurement treatment.
Reducing the scope for accusations of unfair state support may itself ease trade tensions. But turning competitive neutrality into legally-binding guidance will be challenging: China’s state sector is $27.2 trillion.
The following analyst(s), economist(s), or strategist(s) who is(are) primarily responsible for this report, including any analyst(s) whose name(s) appear(s) as author of an individual section or sections of the report and any analyst(s) named as the covering analyst(s) of a subsidiary company in a sum-of-the-parts valuation certifies(y) that the opinion(s) on the subject security(ies) or issuer(s), any views or forecasts expressed in the section(s) of which such individual(s) is(are) named as author(s), and any other views or forecasts expressed herein, including any views expressed on the back page of the research report, accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Qu Hongbin
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