China’s Premier Li Keqiang delivered the work report to the annual National People’s Congress (NPC) today. Premier Li said the government’s GDP growth target for China had been lowered to 6-6.5% in 2019, compared to the target of 6.5% in 2018. Premier Li also announced a value-added-tax (VAT) rate cut for the manufacturing sector, to 13% from the previous 16%. The VAT rate for the construction and transportation sectors will be lowered to 9%, compared to the previous 10%. The target for the government fiscal deficit was set at 2.8% of GDP in 2019 vs. 2.6% in 2018. Premier Li said the government would use proactive fiscal policies and prudent monetary policies to ensure the stability of the economy. He also said two government priorities this year were 1) ensuring sustainable job creation and 2) supporting the development of smaller companies.
At market close on March 5, China’s benchmark Shanghai Composite Index was up 0.9% and Hong Kong’s Benchmark Hang Seng Index was up 0.01%. The Chinese Yuan appreciated by 0.04% against the USD today.
The government’s new growth target at 6-6.5% is an indication that China’s growth is increasingly likely to slow further this year. In 2018, China’s GDP growth was 6.6%, the lowest rate in nearly 30 years. We forecast 6% GDP growth in China in 2019. In particular, we think China’s export growth will ease this year due softer global demand and raised trade tariffs. Household consumption growth is likely to remain modest due to weaker labor market conditions and negative wealth effects from the cooling property market. Corporate fixed investment is expected to remain weak because of cautious private sector sentiment. As we wrote in our CIO Insights Memo after the National People’s Congress last year in March 2018, we believe that the Chinese government will want to put the quality of growth first and will be willing to tolerate slower growth. We think this remains true.
That said, Premier Li’s message today was clear that the government remains ready to moderate the slowdown in economic growth through fiscal stimulus. We had anticipated a cut in the VAT rate, but the 3 percentage point cut was bigger than our expectations. Tax cuts in this round are worth RMB2 trillion, or 2.2% of GDP. The cuts will significantly reduce the tax burden on Chinese corporates. They will be particularly beneficial for manufacturing sectors with low profit margins, such as home appliances, handsets, PCs, etc. Besides, China’s higher fiscal deficit target of 2.8% in 2019 suggests that the government might also be willing to increase expenditure in the slowing economic environment. We think that the government could increase welfare spending with the goal to further poverty reduction, as this is the 70th anniversary of the founding of the People’s Republic of China (PRC). Apart from this, we think infrastructure investment will remain a key focus of government fiscal stimulus: this has already started to pick up since Q4 2018.
China: Lower growth target, more fiscal stimulus
With the stimulus measures today, we think further growth deceleration this year will be in an orderly and controlled manner (i.e. a soft landing). Some stabilization in growth can be expected in H2 this year, as stimulus measures gain more traction. We remain positive on Chinese equities, believing that in the near term they are likely to be supported by 1) the prospect of a positive outcome in U.S.-China trade talks and 2) the possibility of further stimulus measures from China such as more reserve requirement ratio (RRR) cuts and infrastructure investments. In the longer term, we think that favorable factors for Chinese equities include more active foreign investor participation (through the recently-announced increased MSCI weights), fast technology innovation and rising middle class consumption although further bouts of market volatility are possible.
Download this CIO Insights Memo as a pdf here.