While market analysts have been focusing and rightly so on
the protracted trade talks between the USA and China and its effects on the
global stick markets and economies, there has been little discussion on the
underlying strength of the Chinese economy.
This is important if one is to assess future economic growth in that country and its impact on oil demand and oil prices and, in turn, the fiscal health of Gulf oil producers. On the trade talks, things seemed a bit more optimistic. As 2018 drew to a tumultuous close, President Donald Trump went out of his way to highlight the positive tone of a call he had just concluded with China’s President Xi Jinping, focused almost entirely on the state of trade negotiations between the two.
As relayed by Trump, the tone of the call was indeed friendly, but more to the point, the two leaders confirmed a desire to refrain from any further escalation of tariffs, to step up negotiations towards the removal of all additional tariff threats, and to work towards a comprehensive agreement on trade, agreeing to the now formally announced bilateral deputy-level meeting starting in Beijing on January 7 which seem to have gone well as China promised to purchase more American goods causing some uplift in US and global stock markets.
Managing their differences
All these recent interactions are positive signs that the world’s two largest economies are trying to manage their differences to bring ties back on track after months of trade war. Nevertheless, one might not be too uncharitable in noting the real reason for the timing of Trump’s call to XI just may have been to support the US stock market after the ugliest Christmas Eve plunge ever.
While the Chinese will find some comfort in that President Trump needs a successful trade talk outcome for domestic reasons and with some in China possibly urging fewer concessions, the economic picture in Beijing is not exactly one of all roses either.
Following the release of China’s sub-50 (49.4) December 2018 Purchasing Managers' Index (PMI) which are key economic indicators and derived from monthly surveys of private sector companies.
The latest Chinese PMI readings spooked investors – the first contraction since July 2016 and the weakest reading since February of the same year – and the People’s Bank of China ( PBoC ) did not hesitate to announce a 100 basis points cut in their Reserve Requirement Ratio (RRR). That helped, at least for now, stabilize their markets. The Chinese government has now set some policy objectives to ensure that the world’s second largest economy does not go into a recession.
First, the Central Party Committee agreed broadly to implement “countercyclical” and “proactive” fiscal and monetary policies to ensure that GDP would not fall below the coming year’s more modest 6.0-6.5% GDP target, and that the 6.0% GDP floor would be defended at all costs, even in what we believe is the unlikely event there is no agreement with the US to at least de-escalate tensions over trade.
Second, on monetary policy, Premier Li Keqiang flagged the possibility of “some loosening” in 2019 as downward pressure accelerates on the economy, with expectations that the PBoC should be ready to deliver 4-5 RRR cuts next year. That is significantly higher than the end of year market consensus for 3 cuts in 2019 - and the PBoC has the go ahead to even deliver an actual benchmark rate cut if “very necessary.”
Some analysts have noted that even after the cuts announced last night go into effect, the RRR rate for large banks will stall stand at 13.5%, and for small banks at 11.5%. Third, tax cuts that are also to come, as hinted by Premier Li Keqiang which some believe is a suggestion for a 2019 tax cut on businesses and individuals equating to about 1.0-1.2 trillion Yuan. That would be up from the 800 billion Yuan of tax cuts instituted in 2018.
The issue of the Chinese currency and that the Chinese are using it to obtain unfair trade advantage by fixing artificial rates, as opposed to market led rates, has long been a sore point with the United States negotiators. From all accounts even with that stimulus, the Chinese have steered clear of any suggestion they could be targeting or even condoning a weaker currency, sticking to the mantra the Yuan- Renminbi is to be kept at a “basically reasonable and balanced” level.
The desire to avoid political charges from the US or other trading partners over FX depreciation was clearly confirmed in the wake of the RRR, where one stated explanation for splitting the 100 basis points cut into two tranches was to counteract any knee-jerk market weakening of the Yuan. Any structural and fundamental changes in economic direction and policies needs the blessing of the ruling Chinese Communist Party to the leadership.
It would seem the prospects of a looming economic slowdown that will affect many parts of the country has prompted the need to hold a rare Communist Party gathering of all provinces. President Xi Jinping may be clearing the calendar for a long-awaited Communist Party gathering later this month. Nearly half of China’s 31 regions that normally hold annual legislative and advisory meetings have suddenly rescheduled them this month, to create a window from January 19 to 22. That’s the usual length of time required for a full meeting of the party’s Central Committee, which involves more than 200 officials from the government, military and state-owned enterprises and which approves major policy changes.
Is this enough to settle the Chinese markets? The initial readings after the weak PMI number are that both central bank and regulatory sources expect potential big swings in the Yuan FX rate in 2019 due to unsettled global economic fundamentals, political uncertainties, and volatility in equity, bond, and commodity markets.
For these reasons, while that may well translate into more two-way movement for the dollar as well, some analysts still see less room for the dollar to rise in 2019 than it did in 2018 due to domestic US economic slowdown and impasse in the American legislative bodies to act on a bi-partisan basis.
The on-going US Federal Government budget shutdown is only a flavor of what is to come. As for Gulf oil producers, a slowdown in Chinese economic growth will translate into generally depressed oil prices for most of 2019, leading to larger than budgeted fiscal deficits and reserve drawdowns.