The private sector is China’s growth engine. It employs 85 per cent of urban workers and nurtures innovation and technological learning. It accounts for 60 per cent of GDP and an even higher share of investment. But this growth driver has now stalled.
Private businesses slowed after the international financial crisis. Asked to reduce lending, financial institutions continued to favour state-owned enterprises and local government, pushing the bulk of the impact onto the private sector, 95 per cent of which is small and micro businesses.
When regulators realised this, they launched an aggressive campaign to change banks’ lending behaviour. The economy began recovering in 2016 as global growth picked up and China addressed over-capacity in heavy industries and housing. Technological upgrading drove a recovery in capital expenditure.
However, this year private-sector activity – particularly capital spending – has slowed again, depressing the whole economy.
The renewed slowdown stems from Beijing’s ambitious de-leveraging programme but is exacerbated by the trade tensions with the US, which have hit manufacturing exports hardest. Already-jittery businesses are now grappling with dramatic changes in global trade. We estimate that the 25 per cent tariff on USD250 billion of Chinese exports to the US will shave almost 1 percentage point off GDP growth without a policy response to mitigate the impact.
The uncertainty has damaged business confidence, but despite the severe challenges, a mix of structural and cyclical factors provide incentives to invest.
Firstly, although weaker, the business sector is still in better shape than it was. Reduced over-capacity should mean higher future investment, and although corporate profits are worsening, the deterioration is mainly in coal mining and petroleum. And because the private sector de-leveraged most, it has room to reflate and increase capital spending if demand stabilises or picks up.
Further, China’s fast-changing economy – new technologies and a growing consumer base – gives business a strong incentive to invest to move up the value chain and stay competitive.
So if external risk recedes and domestic demand stabilises, investment growth should normalise at a higher level. For both structural and cyclical reasons, China’s private sector can and has room, to reflate.
Since late 2018, China’s policymakers have supported private companies, with the central bank targeting easing on the sector, especially smaller firms. The 2019 fiscal budget includes the corporate sector’s largest tax cut in a decade and lower VAT will generate RMB800 billion to RMB900 billion (about USD125 billion) of tax savings for businesses this year with reduced payroll taxes too.
As these filter through, they will help stabilise near-term demand and should generate a modest recovery in investment growth. However, given the external risks, bigger and bolder policy changes are necessary to revive private businesses. There is room to lift the bond issuance quota to support investment and for even greater cuts in taxes and fees.
And even if the central bank does not rush to follow US interest-rate cuts, it can further support corporate credit demand. Given the challenges raised by the trade tensions, reforms to reduce non-tariff market barriers could level the playing field to boost business confidence.
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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: Julia Wang
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