The power of China

Drew Klease, Principal Economist

Momentum in the global economy has improved markedly over the past year. Real GDP growth in the G20 economies has picked up from a 3% pace in the June quarter 2016 to 3.6% in the June quarter 2017. The improvement has been broad-based, with stronger growth seen in the US, euro area, Japan and most emerging markets.

A key catalyst for the global economic recovery has been a turnaround in China. Between 2014 and 2016, China was plagued by bouts of instability, including a bubble and subsequent collapse in equity prices, capital outflows and significant currency devaluations, and a large slowdown in investment, industrial production and external trade. Real GDP growth in China dropped from 7.8% in 2014 to 6.7% over the first-half of 2016.
 
The slowdown in China, particularly in construction activity, led to a sharp correction in global commodity prices. Iron ore, coal and base metal prices all fell significantly, with the RBA commodity price index plummeting 50% between the end of 2013 and early 2016. Lower demand from China and weaker commodity prices weighed heavily on global growth, particularly for commodity exporters. Russia and Brazil fell into a deep recession, while Australia also fared poorly. 

However, since early 2016, the Chinese authorities have pursued additional fiscal stimulus to support growth. Growth in China has rebounded, with real GDP firming to 6.9% over the year to the June quarter 2017. While this improvement may not seem like a lot, much stronger gains were evident in industrial production and construction investment, which has helped support global growth and lead to a 55% rebound in commodity prices. This has helped lift Brazil and Russia out of recession, while signs of improvement have also been evident in Australia.       

The improvement in Chinese growth has been manufactured by authorities to help crystallise support ahead of the 19th National Congress of the Communist Party that begins on 18th October. This meeting is the key political event in China. It’s held once every five years and determines the leadership of the party.

While President Xi Jinping will return for a second term, the meeting will reshape the composition of the senior leadership team. The key uncertainty around the Congress is whether President Xi will be successful in further centralising power and what the subsequent policy direction of the leadership team will look like. 

Our baseline view is that President Xi will adopt a slightly quicker pace of reform at the cost of slightly softer economic growth, of around 6-6.5% in 2018. Growth maintained around this pace should be sufficient to achieve the party’s goal set in 2010 of doubling GDP by 2020. We expect President Xi will focus on further reform to limit systemic risks, including increased financial regulations, limiting debt growth, additional regulation of the shadow banking sector and increased reform of state-owned enterprises. President Xi will also continue to push for reforms that ensure growth is more inclusive and sustainable, focussing on environmental regulations, poverty reduction, health care, pension reforms and hukou (or household registration) reforms. 

A moderation of growth in China during 2018 will see some of the recent strength in commodity prices ease and remove some of the tailwinds supporting the global economy. Nonetheless, with underlying fundamentals improving in most economies, global growth should be able to be maintained around its current pace.   

While our baseline view is for an incremental shift in the reform agenda, it is possible that President Xi could receive much more power and a mandate for significant reform. With the party’s 2020 goals in sight, President Xi could outline a new vision for 2030, embarking on a more radical reform effort. Such an outturn could be welcome news for the longer-term Chinese outlook, but with the potential for slightly slower near-term growth. 

On a variety of fronts, it is clear that the power in the global economy is shifting to China. What the incoming powerbrokers in China decide to pursue will be a key factor shaping the growth of the global economy over the next five years.  

Table 1: Financial market movements, 28 September – 5 October 2017


Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,552.1

1.7%

US

2.35%

3.9 bps

US Dollar Index (DXY)

93.96

0.9%

Nikkei 225

20,628.6

1.3%

Japan

0.05%

-2.8 bps

USD-JPY

112.82

0.4%

FTSE 100

7,508.0

2.5%

UK

1.39%

1.2 bps

GBP-USD

1.312

-2.4%

DAX

12,968.1

2.1%

Germany

0.46%

-2.3 bps

EUR-USD

1.171

-0.6%

S&P/ASX 200

5,651.8

-0.3%

Australia

2.79%

-7.6 bps

AUD-USD

0.780

-0.8%

Source: Bloomberg



Economic Update

United States

Positive conditions for US manufacturers
  • Manufacturing activity advanced at the fastest pace in over 13 years in September, according the monthly ISM manufacturing index. The strength partly reflected impacts from hurricanes Harvey and Irma, which pushed up new orders and lead times for supplier deliveries, both of which are components in the headline index. The prices paid subcomponent also rose strongly, and the ISM noted that many respondents were concerned about further hurricane-related increases to input costs. The index has been strong for some time however, and growth was broad-based across subcomponents and industries.
  • Growth in personal spending slowed in August, falling to 0.1% in monthly terms following 0.3% growth in July. Hurricane Harvey likely had an effect on the data, with a fall in auto sales the leading contributor to a decrease in spending on goods. In real terms, consumption spending fell 0.1% in August following six months of growth. Personal income grew 0.2% in August, down a little from 0.3% growth July. 



Euro area / United Kingdom

Higher energy prices supporting inflation in the euro area
  • Year-ended headline inflation remained unchanged at 1.5% in September in the euro area, supported again by higher energy prices, while core measures of inflation were mixed but little changed. 
  • The euro area unemployment rate was steady at 9.1% in August for the third consecutive month.



China / Japan

Mixed signals from China PMIs
  • The official manufacturing PMI increased in September to 52.4 from 51.7 in August, despite other recent data suggesting that China’s economic growth has slowed a little. The independent Caixin-Markit manufacturing PMI, which focuses mainly on private manufacturers, declined in September after rising for three straight months. 



Australia / New Zealand

Retail sales fall sharply in Australia
  • Dwelling approvals ticked up a little in August, growing 0.4% from the month before. Approvals were 15.5% lower than a year earlier however, with a 29.2% fall in approvals of non-house dwellings outweighing a 3.1% rise in house approvals.
  • Retail sales fell 0.6% in August, as consumers continued to cut spending on household goods and cafes, restaurants and takeaway foods, while also spending less at other food retailers. This was the largest monthly decline since March 2013, and follows a 0.2% decline in July, a particularly weak result given large monthly declines often follow a strong gain in the preceding month. This points to downside risk to household consumption for the September quarter, after holding up resiliently in Q2 as a decline in the saving rate propped up consumption amidst sluggish disposable income growth.
  • The Reserve Bank of Australia left the cash rate target unchanged at 1.5% at their meeting earlier in the week.




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