The Good News Hidden in China’s Economic Slowdown

There’s good news hidden in China’s tumbling stock markets and slowing economy. A government bid to curb risky lending, clean up industry, and restrain home prices is holding firm even as economic growth heads for its slowest annual pace in almost thirty years and the US trade standoff threatens to deepen.

Rather than reaching for the old investment spending and monetary binge playbook of 2009 or 2015, Beijing is cushioning economic blows with targeted tax cuts, investment incentives and efforts to get more credit to efficient private-sector companies.

Chinese President Xi Jinping may be nudging his nation onto a more sustainable growth path even if it means swallowing some losses along the way.

“Chinese leaders have made impressive initial success in reining in some of the most speculative parts of China’s financial system,” said Andrew Polk, co-founder of research firm Trivium China in Beijing. “Many analysts aren’t recognizing these considerable initial gains.”

For the world, the prospect of steadier economic growth, even if at a slowed pace, is welcome. And because China is so much bigger than it used to be, 6% growth can produce just as much global demand as the double-digit gains of old, meaning China will remain the world’s biggest growth engine.

One dividend from Xi’s policies to rein in excesses is productivity growth, which has risen from an average of about 1.9% annually between 2014 to 2016 to about 2.4% this year, said Morgan Stanley chief China economist Robin Xing in Hong Kong.

Among key factors driving the improvement is the elimination of excess industrial capacity in industries from steel to cement.

Xing estimates the increase of debt will be flat this year, leaving the total ratio at about 276% of gross domestic product and says it’s poised to rise about three percentage points in 2019.

That compares to annual average 15%age point increases between 2007 and 2015.

“It’s the first time China’s policy easing is mainly focused on fiscal rather than monetary policy,” said Xing. “They won’t be giving up their hard-earned achievements on leverage and capacity control.”

When viewed with a longer lens some of the pain Xi’s policies are inflicting on investors and companies can be seen as a good thing.

Consider corporate defaults, which are at a record this year as the squeeze on shadow banking continues. The IMF and World Bank have long argued that the removal of implicit guarantees would reduce moral hazard and allow risk to be meaningfully priced.

That is starting to happen. As the chart below shows, foreigners are piling into China’s bond market.

For Xi, there is a red line for the slowdown. He needs enough demand to meet the target of creating 11 million jobs a year (already met for 2018) and bottom-line economic growth of about 6.2% for the next couple of years to deliver on a pledge that 2020 GDP and income levels would be double those in 2010.