Economy

Reading the tea leaves

Is 2019 shaping up to be a bad year for China?

Meng-Wanzhou-w

Meng is still detained in Canada

“Those with knowledge don’t predict. Those who make predictions don’t have knowledge.” Thus intoned Lao Tzu, the ancient Chinese philosopher who founded Taoism. In spite of this sage advice we will still start the year by forecasting five of the main themes likely to make headlines in the months ahead. Here are WiC’s suggestions:

One: coming to terms in the trade war

Officials from both governments are met this week for the first face-to-face talks since they agreed to a 90-day truce in December. Both Chinese and US stocks have rebounded in the first week of the year on hopes that Beijing and Washington could iron out their difference (“Talks with China are going very well!” Donald Trump tweeted this week.) It took time for the two countries to feel the fuller effect of the trade conflict with many businesses shoe-horning their orders into the period before the worst of the tariffs came into force. Now there is a sense that the consequences are becoming clearer, especially in China, where the central bank again cut the cash that lenders have to hold as reserves last week, freeing up $116 billion for new loans as it tries to reduce the chances of a sharper slowdown.

These kinds of conditions have convinced Donald Trump that Beijing is keener to reach an agreement and it’s true that the mood in China seems more conciliatory than earlier in the trade row.

A separate question is how badly the Americans are hurting from events, highlighted by the collapse in Chinese demand for iPhones, which sliced nearly $75 billion off Apple’s market cap in a single day in the first week of January. Trump’s team shrugged it off as more evidence of the slowdown in China, pointing to better-than-expected news on US job creation through December. But analysts query whether the prospects of the two markets can really be kept apart and they are asking whether a prolonged slump in demand from China is going to damage more firms than Apple.

More signs of a slowdown could spill over into steeper falls in US stock markets, which suffered from drastic declines over the final months of last year. So the race is on to reach a compromise deal before the start of March, when Trump is threatening to put higher tariffs on a fuller range of Chinese goods.

Two: time to boost the economy

A long period of debt deleveraging has also had a dampening effect on the Chinese economy. The campaign against easy credit will continue this year, much to the consternation of the country’s smaller and medium-sized enterprises, which complain that it makes it even harder to secure bank financing. The deleveraging effort has also been making life difficult for massive conglomerates like HNA and Wanda, which have been trying to get their balance sheets in order after years of expensive dealmaking, often overseas.

Back in China confidence in the economy has been in diminishing supply with suggestions that the media is being warned against negative reporting. In December there was an account from Caixin magazine that the state statistics bureau had even stopped the release of surveys of manufacturing activity in Guangdong. All the same, last week’s national data on manufacturing couldn’t mask the first monthly contraction since 2016 and the government has been responding to the deteriorating mood with a steer back towards stimulus.

Infrastructure investment had already rebounded over the last three months and there was news this week that the authorities have approved rail projects worth almost $125 billion over the past month, including six new subway lines in Shanghai and four more in Wuhan (for more on that city’s expanding metro system see our latest Sinopolis city guide on our website).

Economists also argue that there is scope for more fiscal fizz, with tax cuts for corporations set to follow the reductions in income tax granted to individuals last October. All in, HSBC still expects GDP growth of 6.6% for the full year, a similar performance to last year, but longer term the focus will stay on domestic consumption, which China wants to become the key driver of its growth.

The immediate situation here is a little discouraging: growth in retail spending slowed to its lowest level in 15 years in November and China has just post its first annual decline in car sales since 1990 (unit sales fell 6% in 2018). Meanwhile, officials from policy planners NDRC this week have already sounded out plans to introduce incentives to boost car sales.

Three: more trouble over technology

Interlinked with the trade row between China and the US is the struggle over leadership in technology, which has been one of the focal points of Beijing’s ‘Made in China 2025’ plan, which seeks to reduce reliance on American suppliers.

Chinese policymakers have gone quiet on the programme because they know it plays poorly with Western governments. But it remains a mainstay of their efforts to repurpose the economy and it was given new urgency by the humbling of telecom manufacturer ZTE last year by an embargo on American components (see WiC406).

This year more of the attention will turn to ZTE’s larger rival Huawei, with a spate of stories in recent weeks about how developed countries are determined to prevent it from winning new 5G contracts because of security concerns about its links to the Chinese authorities.

The situation has taken on new intensity with the detention of Meng Wanzhou, a daughter of the company founder, on allegations of sanctions busting in Iran (see WiC435).

Huawei’s supporters sense something more behind the antagonism, saying that its leadership in 5G has alarmed its international competitors. We forecast more fury from the telecom giant this year as it is blocked from more contracts. Growth in more welcoming markets in Africa and Asia will make up some of the shortfall but Huawei will struggle to gain more traction in Europe, having all but been shut out of North America.

Of course, rows like these will also trigger more insistence from policymakers that Chinese firms have to become more self-reliant in component manufacture, especially in areas like semiconductors. Currently, the catch-up has been faster in chipmaking for smartphones, rather than heavier duty chips for applications in areas like autonomous vehicles. There will be more fanfare about achievements in these fields this year (not always convincingly) and right on cue Huawei put out news this week about the design of a new type of semiconductor that sets new standards in terms of Big Data capacity and distributed storage.

Most commentators, including Chinese ones, think it is going to take longer to close the gap completely. Nonetheless, Chinese firms have little choice but doing the work themselves: the political situation now makes it almost impossible to acquire the expertise by buying leading edge Western firms.

Four: a tougher year for China’s unicorns

Two of China’s internet giants will be hoping for a ‘reset’ this year. JD.com has seen its stock price slump since allegations about the personal conduct of its founder Richard Liu (see WiC424), while Tencent will want to recover from a disastrous period in which it reported its first decline in quarterly profits for more than a decade (see WiC421).

Tencent’s fortunes had risen to such a level that it was due some turbulence, but key for this year is clarity on delays on new product releases from its gaming division.

There were approvals for 80 new titles at the end of December in the first batch of licences to be granted by the media regulator for nine months. Tencent’s games were notably absent from the list, as was the case this week when another batch of games was waved through.

A host of other internet brands emerged last year to rival the likes of Tencent and JD.com (see WiC425). Pinduoduo – talked about as another of the main challengers to e-commerce king Alibaba – will be watched for signals on consumer sentiment, especially from lower tier cities. And Meituan-Dianping, China’s ‘everything app’, is pioneering the O2O revolution, which now extends from group buying and food delivery into ‘new retail’ scenarios such as supermarkets and unmanned stores.

Ride-hailing app Didi had a terrible 2018 after two of its female customers were murdered by their drivers. This prompted a period of introspection from its management team, which is promising to refocus on customer safety. There was also the admission in September that the company lost Rmb4 billion ($582 million) in the first half of 2018 and this year began with an announcement that Didi is diversifying into new areas, including financial services and insurance (see this week’s “Banking and Finance).

The struggle was similar for China’s two top bike-sharing apps, which both looked a lot less triumphant after cash crunches wreaked havoc on their plans for consolidation last year. Mobike stayed on the road by accepting a buyout bid from Meituan-Dianping, but Ofo rebuffed a takeover approach from Didi, despite speculation that it was on the brink of bankruptcy. Both companies will be watched closely for signs of more sustainable cycling this year.

The most successful of the start-ups last year was Bytedance, an AI-powered news app that has diversified into other areas including short-form video (see WiC383). Recent fundraising rounds have valued it at $75 billion, putting it on par with web search king Baidu. It is now said to be planning an IPO of its own this year, although another intriguing option would be some kind of merger with Baidu (see this week’s “Cartoon”), which could allow both companies to take closer aim at their respective rivals Alibaba and Tencent.

Bytedance already shows every sign of taking the battle to Tencent, with news in the Chinese media that it is planning to launch a messaging app that competes with WeChat.

Five: Xi Jinping fosters yet more friendships overseas

Finally, what will be the international priorities for China’s leader?

There have been setbacks for the specific area of foreign policy most directly associated with Xi’s leadership, the Belt and Road Initiative, which promises a multiyear programme of global infrastructure investment. Much of the second half of last year was characterised by complaints from some of the recipients of Chinese funding, including criticism that host nations had little prospect of paying back their debts. There have been demands from countries like Malaysia, Sri Lanka and Pakistan to renegotiate the terms of some of the investment.

Opponents of the plan had warned the Chinese that they would run into these kinds of difficulties and Beijing has ordered a review of much of the business done to date, aware that the publicity has been damaging. The number of deals sealed last year was already down on previous years, while China’s leading banks have been getting more encouragement to partner with other international lenders in future projects.

Expect more emphasis on this more inclusive style in the lead-up to the second Belt and Road Forum (likely in April), which Xi will host. There will also be talk of a more disciplined focus on the commercial returns of the new roads, ports and railways that are being built, so that recipient governments can be more confident about paying off their loans from the Chinese.

Bigger picture, Xi’s clash with Trump (whatever the American president says about their personal chemistry) has encouraged a shoring up relations with some of his neighbours.

Diplomatic ties have warmed markedly with the Japanese over the past 18 months and there is an expectation of a high-level visit to Beijing in the coming weeks. Kim Jung-un made another surprise visit to Beijing this week. And Xi continues to cultivate his relationship with Vladimir Putin as well. The two leaders accepted each other’s invitations for another round of visits in the first half of this year. China’s relationship with India has also improved, following a fraught period in 2017 over a stretch of frontier disputed with Bhutan.

Relations with EU nations could get testier, however, following the launch from Brussels of new screening standards for overseas investment in what looks like an attempt to repel Chinese interest in strategic sectors such as robotics and aerospace.

Relations with erstwhile friendly Canada will be in focus thanks to the potential extradition to the US of Huawei’s Meng; while another flashpoint with the US could escalate over Taiwan, particularly if Trump changes the terms of engagement with the island – which Beijing deems a “renegade province” – or escalates arms sales. (For more on the current heating up of Cross Strait politics, see this week’s “Cross Strait”.)

Not that Xi is toning down the message that China will protect its own interests vigilantly or his insistence that it will never be pushed into changes demanded by other nations. “No one is in a position to dictate to the Chinese people what should or should not be done,” he said in a speech marking the 40th anniversary of the opening up of the Chinese economy last month.

“We must resolutely reform what should and can be changed, we must resolutely not reform what shouldn’t and can’t be changed,” he added with rhetorical defiance.


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