China heats up domestic economy to counter trade headwinds

China has been adopting measures to heat up its domestic economy, including liquidity injection, tax cuts and easing of strict anti-pollution policies to ward off adverse impacts on growth from its escalating trade war with the US.

Exports, which are a major growth engine for the economy, can expect a major hit amid China’s escalating trade spat with the world’s largest economy and importer of more than $500bn worth of Chinese goods in 2017.

About half of the total Chinese goods imported by the US are now subject to tariffs, which were slapped over three rounds – $34bn on 6 July, $16bn on 23 August and $200bn on 24 September.

China adopted a tit-for-tat strategy in responding to the US’ tariffs, but was constrained by a smaller US export exposure of about $130bn, based on US 2017 data.

$110BN OF US IMPORTS

China’s retaliatory tariffs were imposed on a total of $110bn worth of US goods, while the US is threatening to impose tariffs on additional $267bn worth of Chinese goods, essentially putting all Chinese imports under tariff.

The trade row would shave 0.7 percentage points from China’s GDP growth, according to the International Monetary Fund (IMF), but domestic policies could bring down the net negative economic impact to 0.2 percentage point. For 2019, the IMF cut its growth forecast for China to 6.2%, but maintained its 6.6% growth projection for 2018.

Citing higher risk to financial stability amid growing trade tensions, global growth forecast was trimmed to 3.7% for 2018 and 2019 from 3.9% previously, based on IMF’s October World Economic Outlook (WEO). The IMG has assigned a 5% probability that emerging markets may suffer capital outflows of more than $100bn over four quarters.

The Chinese economy had been steadily slowing down for six years from 2011, before springing a surprise uptick in growth in 2017, when it logged 6.9% growth.

A deceleration in GDP growth was projected by the Chinese government this year even before the trade war with the US ignited in the second half of 2018.

China’s official growth target of around 6.5% this year may be at risk as the US-China trade war starts to have a direct hit on economic activities.

Cognizant of downside risks to GDP growth, China’s central bank has been directly injecting liquidity into its financial system via reduction in the reserve requirement ratio (RRR) for banks. The fourth such cut this year took effect on 15 October.

The announced one percentage point cut in reserve requirements, which refer to the portion of deposits that financial institutions must park with the central bank, will release a total of yuan (CNY) 1.2tr ($173bn) of liquidity, of which CNY750bn in cash will injected into the financial system to boost domestic consumption and encourage lending for enterprises.

Come November, China will further raise export tax rebates on some goods currently enjoying rates of 5%, 9% and 13-15%, provided they are not energy intensive, highly polluting, resource-based products, or products in overcapacity. It is a follow-up to the 15 September increase of tax rebates on 397 items, including electronics and culture products. Increased export rebates should encourage domestic enterprises to ship out more products.

The yuan’s weakness, which is largely a consequence of the ongoing trade war, is a boon to the export industry as it makes Chinese products more competitive, but the more pressing challenge for exporters is to find new markets that would replace the US.

The Chinese currency has shed more than 10% of its value against the US dollar since early February and is currently trading near its lowest level since late-December 2016.

An effective easing of China’s monetary policy is further exerting downward pressure on the yuan.

TAX CUTS

On the domestic front, the government has been cutting taxes to boost consumption, which should help keep the economy churning at a good pace.

Starting 1 October, the income tax rate for individuals was reduced, with the minimum taxable monthly wage set higher at CNY5,000 from CNY3,500 previously.

Meanwhile, individuals’ expenditures covering children education, mortgage loan interests, rentals and parents caring can all be exempted from income tax starting 2019.

In May, the valued added tax (VAT) was cut by one percentage point to 16% for manufacturing; and to 10% for transportation, construction, telecommunications, agricultural and other sectors.

Further tax reduction measures are being considered, including a possible cut in corporate tax from the current 25%.

China has pledged at the start of the year tax reduction measures valued at about CNY1,100bn, which was raised to CNY1,300bn when the trade war with the US began.

China has been progressively bringing down the country’s overall tax burden, which stood at 27.2% in 2017, down from 28.2% in 2016 and 29% in 2015, according to the Ministry of Finance.

On its war against pollution, China has had to soften its stance amid current threats to economic growth. The Ministry of Ecology and Environment (MEE) has not set any production curbs for the upcoming winter season, allowing instead local authorities to make the call based on local emission situations.

On reducing PM2.5 – a hazardous fine particulate matter – in Beijing-Tianjin-Hebei and surrounding areas, the targeted year-on-year decline was trimmed to 3% from a preliminary proposal of 5% over a six-month period from October.

In the previous years, China’s environment watchdog had mandated 30-50% output cuts of highly polluting industries, such as steel, cement and chemicals from October to March – to which local governments had typically responded with a blanket shutdown of these factories.

On the mandated shift to using gas instead of highly polluting coal, the implementation will be somewhat relaxed following the government’s hardline stance last year that saw a number of households scrambling for supply of gas, whose prices spiked to multi-year highs.