21st January 2019 – China’s 4Q GDP report showed real GDP growth came in line with expectations at 6.4%oya (J.P. Morgan and consensus: 6.4%), compared to 6.5%oya in 3Q. Based on our seasonal-adjustment process, in sequential terms the economy grew 6.1% q/q saar in 4Q, compared to 6.0% q/q saar in 3Q (for comparison, the NBS seasonally-adjusted series suggests 4Q GDP growth eased to 1.5% q/q sa, compared to 1.6% q/q sa in 3Q). Besides, in nominal terms, 4Q GDP rose 9.2%oya, compared to 9.4%oya in 3Q. The implied GDP deflator eased marginally to 2.6%oya in 4Q, compared to 2.7%oya in 3Q. For full year 2018, real GDP grew 6.6%yoy (compared to 6.8%yoy in 2017, which was revised downward from the previous print of 6.9%yoy).

In addition to the 4Q GDP report, the high frequency monthly activity data for December shows that, on the production side, IP growth picked up moderately (at 0.5% m/m sa) in December. Regarding aggregate demand conditions, on the external front, December trade report came in notably weaker-than-expected, with slowing across exports (down 6.6% m/m sa) and imports (down 15% m/m sa). On domestic demand, retail sales recovered moderately in December as we expected, growing 0.6% m/m sa, following the disappointment in the previous two months. Meanwhile, fixed investment growth came in modestly below expectations, rising 5.9% for full-year 2018 (unchanged from the growth pace in Jan-Nov). In particular, infrastructure investment growth turned up modestly in December, while real estate FAI growth eased moderately, with manufacturing FAI holding on to a solid growth pace.

A few features of the latest economic landscape are worth noting.

• Regarding the structure of the economy, in fully year 2018, consumption contributed to 76.2% of headline GDP growth (vs. 57.6% contribution in 2017), investment contributed 32.4% (vs. 33.8% in 2017), while net exports subtracted 8.6% from headline growth (vs. +8.6% in 2017). Besides, service sectors constitute 52.2% of total GDP in 2018.
• Regarding latest momentum in the economy, on the production side, the sequential trend in IP growth picked up moderately to 0.5% m/m sa in December, compared to 0.2% m/m sa in November.
• On the external front, December exports fell notably by 6.6% m/m sa, adding to the decline of 3.4% m/m sa in November. Details suggest plunge in shipment to the US (down 10.3% m/m sa in December), likely to be partly related to US tariff measures. Meanwhile, broad-based slowing was registered for exports to other major markets as well, including shipment to EU (down 5.9% m/m sa) and Japan (down 3.0% m/m sa).
• On the domestic front, fixed asset investment rose 5.9%oya in full-year 2018 (and 5.9%oya in December alone). Infrastructure FAI had been the major factor dragging overall FAI growth earlier in the year. Following notable policy support since mid-year, infrastructure FAI growth has recovered moderately lately, rising 3.8%oya for the full year (vs. 3.7%oya in Jan-Nov). According to our estimate, for the month of December alone, infrastructure FAI grew 6.2%oya (compared to 4.4%oya in November). Besides, manufacturing FAI growth has shown solid growth in recent months, rising 9.5%oya in full year 2018 (unchanged from the growth rate in Jan-Nov). Meanwhile, the pace of growth in real estate FAI eased moderately to 7.4%oya in the month of December, compared to 9.7%oya in November. In addition, private sector FAI registered solid growth at 8.7%oya for full-year 2018 (unchanged from the growth rate in Jan-Nov).
• On the consumption side, following the disappointment in Oct-Nov, retail sales recovered moderately in December, rising 8.2%oya (or 0.6% m/m sa). In further details, the auto sector remained the key drag, as auto sales (unit of cars) fell 0.7% m/m sa in December. Meanwhile, retail sales ex-auto picked up nicely, rising 1.3% m/m sa in December, compared to 0.8% m/m sa in November.
• Labor market conditions seem to be relatively stable so far, as nationwide urban survey unemployment rate came in at 4.9% in December (compared to 4.8% in November, and 5.0% in December 2017). Regarding household income conditions, average nationwide household disposable income per capita (in real terms) rose 6.5%oya in full-year 2018, compared to the rise at 6.6%oya in the first three quarters. Besides, full year 2018 urban new job creation came in at 13.61 million (compared to the official target of 11 million, and new job creation at 13.51 million in 2017).

Fine-tuning the 2019 growth trajectory: weaker 1Q followed by a modest recovery

We have emphasized the downside risk to our current quarter GDP forecast in recent weeks. December trade activity was much weaker than expected, pointing at weaker-than-expected domestic as well as global demand. Today’s December activity report was mainly in line with expectations, especially regarding retail sales and FAI activity (if adjusted for lower-than-expected PPI in December), with IP holding up better than expected.

We revise down our current quarter growth forecast from 6.1%q/q saar to 5.9%q/q saar. The cut is mainly driven by weaker-than-expected export activity, probably reflecting the impact of US-China tariff war or rising uncertainty in trade environment and likely weaker-than-expected global demand. On the domestic front, we maintain our cautious view on investment but worry less about consumption. FAI may have a weak start in the year due to continuous softening in real estate investment, a temporary funding gap for local government sponsored infrastructure investment and expected easing in manufacturing investment. By contrast, consumption growth will benefit from the new tax code for household income (middle-income families will benefit the most) that has fully taken effect since January 1, 2019.

We also revise up our 2Q and 3Q growth forecasts to 6.2%q/q saar and 6.4%q/q saar (previously 6.0%q/q saar and 6.3%q/q saar), and maintain our 4Q growth forecast unchanged at 6.2%q/q saar. Our full-year 2019 growth forecast stays unchanged at 6.2%oya. The modest recovery is a bit stronger than previously forecasted for two reasons. First, policy easing has been bolstered in recent weeks, mainly on the fiscal and monetary policy fronts, and we expect more to come. In particular, on the fiscal side, following last year’s announcement of a tariff reduction (from 9.8% to 7.5%), an increase in tax rebate for exports, and lower individual income tax, the authorities announced a tax cut of 200 billion per year in 2019-2021 for small business, and we expect a significant VAT cut, fiscal subsidies on home appliance and auto purchases and expansion in fiscal deficit targets will be announced in the coming months. On the monetary policy front, we expect financial market interest rates will continue to move lower, with a likely cut in 7-day reverse repo rate in March and another 100bp RRR cut in early 2Q. TSF growth will likely bottom out in the coming months. While policy easing is broadly in line with our expectations, the magnitude and pace are supportive of a recovery that may start in mid-2Q.

Second, the US-China trade negotiation appears to be moving in a more constructive direction, and optimism for a trade détente is increasing ahead of China vice premier Liu He’s trip to the US on January 30-31. The working-level meeting in the first week of January and follow-up news suggested that a wide range of issues were discussed. In the last few days, Bloomberg reported that US officials are considering easing Chinese tariffs to hasten a trade deal, and China has offered to significantly increase imports from the US by a combined value to more than US$1 trillion by 2024. It seems that positive progress has been made in trade negotiation, although it remains unclear how gaps in structural issues such as IP protection, forced technology transfer, and other non-tariff issues will be addressed. We maintain our view that the March 1 deadline will likely be extended, but the probability of a full-blow tariff war (25% tariff on all Chinese imports by the US) in 3Q19 is lower than we previously assumed. The possibility of a partial deal is increasing. A partial deal does not add much upside risk to the medium-term growth outlook for China, given that it will involve China’s strong commitment to a significant increase imports from the US (hence the negative impact on trade balance will remain, although the shock will come less from exports and more from imports). In addition, non-tariff measures could replace tariff measures if structural issues are left open, and the negative impact on business sentiment and relocation of global supply chain will remain. The key difference, with a lower probability of a full-blown tariff war in 3Q, is that the impact will likely be evenly spread out rather than a sudden blow in 3Q.

Further details of the December activity data

• Industrial production came in stronger than expected, growing 5.7%oya in December (J.P. Morgan: 5.1%; consensus: 5.3%), compared to 5.4%oya in November. Seasonally-adjusted, the pace of growth IP turned up to 0.5% m/m sa in December, compared to 0.2% m/m sa in November.
• In terms of output (volume) of major products: (1) Electricity production grew 6.8%oya in full year 2018 (or up 6.2%oya in December alone), compared to the growth at 6.9%oya in the first 11 months (or up 3.6%oya in November alone). (2) Production of cement rose 3.0%oya in the full year (or up 4.3%oya in December alone), compared to the increase of 2.3%oya in the first 11 months (or up 1.6%oya in November alone). (3) Production of automobiles fell 3.8%oya in the full year (or down 14.9%oya in December alone), compared to the decline of 2.3%oya in the first 11 months (or down 16.7%oya in November alone). (4) Production of crude steel rose 6.6%oya in the full year (or up 8.2%oya in December alone), compared to the rise of 6.7%oya in the first 11 months (or up 10.8%oya in November alone).
• For domestic demand conditions, retail sales grew 8.2%oya in December (J.P. Morgan: 8.2%; consensus: 8.1%), compared to 8.1%oya in November. Seasonally-adjusted, this translates into a moderate upturn in growth at 0.6% m/m sa in December, compared to 0.4% m/m sa in November. Further details show retail sales ex-auto rose 1.3% m/m sa in December, compared to 0.8% m/m sa in November. Meanwhile, auto sales (in terms of unit of cars) fell 0.7% m/m sa in December, following the decline of 2.9% m/m sa in November. Besides, online retail sales grew 23.9% in full-year 2018, compared to the growth at 24.1% in the first 11 months.
• Fixed asset investment grew 5.9%oya in full-year 2018 (J.P. Morgan and consensus: 6.0%), compared to 5.9%oya in Jan-Nov. Our calculation showed that nominal fixed investment grew 5.9%oya in the month of December (vs. 7.7%oya in the month of November). Within the space of fixed investment: (1) Manufacturing investment continued with solid growth at 9.5%oya in full year 2018, unchanged from 9.5%oya in the first 11 months. (2) Infrastructure investment growth turned up modestly to 3.8%oya in the full year, compared to 3.7%oya in the first 11 months. In particular, investment in transport infrastructure rose 3.9%oya in the full year, (vs. 4.5%oya in the first 11 months), while investment in water conservation and environment management rose 3.3%oya (vs. 2.4%oya Jan-Nov). (3) Real estate investment growth eased modestly to 9.5%oya for the full year, compared to 9.7%oya in the first 11 months.
• Private investment grew 8.7%oya in full year 2018, compared to 8.7%oya in Jan-Nov (and 6% in 2017). Meanwhile, public investment growth edged down to 1.9%oya for the full year, compared to 2.3%oya in Jan-Nov (and 10.1% in 2017).

With regard to the housing market:

• Home sale area rose 2.5%oya in December, following the decline of 3.7%oya in November. In value terms, home sales grew 13.6%oya in December (vs. 13.3%oya in November). Meanwhile, total floor space started continued to grow at an elevated pace of 23.4%oya in December (vs. 22.5%oya in November).
• Real estate developers raised 16.6 trillion yuan in full year 2018 (up 6.4%oya), compared to 15.0 trillion yuan in the first 11 months (up 7.6%oya).
• Among major funding sources, advanced payments from pre-sales rose 13.8%oya and accounted for 36.9% of total funds in full year 2018, mortgage payments fell 0.8%oya and accounted for 14.4% of total funds, self-raised funds rose 9.7%oya and accounted for 32.8% of total funds, and bank loans fell 4.9%oya and accounted for 13.8% of total funds.