Navigating in an uncertain external environment: China 2019 Macro Outlook

Headed into 2018, global economy was on a synchronized reflation path. However, it was interrupted by severe tightening of financial conditions in China, and to a lesser extent, rapid escalation of China-US trade friction.

Looking into 2019, we stand to find out whether the slowdown in most economies in 2018 will turn out to be a mid-cycle correction or the start of a prolonged downward trend. In our view, the medium-term trajectory largely hinges on how policies adjust in China and the US. We present our macro outlook under 3 scenarios based on different policy trajectories.

In our base case scenario, we assume notable yet insufficient adjustments of the cyclical management policies in China, as well as partial relief of the China-US trade friction. We see real GDP growth at 6.4% YoY & 6.3% YoY in 2019-20, nominal growth falling to 8.4% YoY & 7.9% YoY. Inflation may moderate, esp. for PPI & property prices.

In the “base case”, fiscal policy may bear the brunt of counter-cyclical management by expanding the realized general deficit by ~1.5ppt of GDP in 2019, mostly via reducing fiscal burden of the corporate sector. Monetary policy will likely stay accommodative – we foresee 200bp RRR cut in 2019 but no rate cuts. Market rates may fall, with ~50bp drop in weighted average lending rate & ~20bp decline in 10Y T yield. Our baseline forecast indicates that USD/CNY may oscillate around 7.12 in 2019, with the “band” of + or –3ppt around this “central line”. Much like our projected growth path, CNY may dip before stabilization.

In the “blue sky” scenario, both China & the US will adjust policies sufficiently, with the US backing down from trade tariffs & China boosting domestic demand decisively. In this case, we may see real GDP growth of 6.6% YoY & nominal growth at 9% YoY in 2019.

In the bear case, neither the US nor China adjust their current policy trajectory, i.e. China remains behind the curve in cyclical mgmt & US China trade friction escalates further. In this case, China’s real GDP growth may drop to 6%; PPI may fall below 0 & drag nominal growth down to 6.5%. The deeper dip in growth & asset prices may trigger forceful easing on both the fiscal & monetary fronts in mid-year 2019.

We see three main risks to our current baseline scenario, including potential deterioration of external demand, delays in policy adjustments in China that result in an even sharper slowdown of property investment, & an “unanchored” CNY depreciation episode that inadvertently tightens financial conditions in China & leads to rising risks across global markets.

Meanwhile, growth & asset prices will respond positively if China adjusts domestic policies swiftly & makes progress on efficiency enhancing reforms.