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China’s Finally Rebalancing the Economy, But Still Losing Out

Key Chinese economic indicators have fallen short of expectations, suggesting that the domestic economy is feeling the pinch from the ongoing US-China trade tensions and a weaker global backdrop.

Pumping the brakes on economic growth

Across the country, macroeconomic indicators are slowing down. China’s GDP growth of 6.6% in 2018 was its slowest pace since 1990. China’s automotive sales reached 28.1mn in 2018, a 2.8% drop from 2017, while national retail sales have hovered between 8.1% and 9.2% since May 2018.

But on the whole, China’s economy is rebalancing. Since coming to power in late 2012, President Xi has pushed a reform agenda aimed at strengthening household purchasing power while decelerating fixed asset investments as economic drivers. Domestic consumption now accounts for more than half of the economy.

Decelerating GDP reflects Beijing’s ambitions for an economy driven by quality (household consumption) over quantity (infrastructure projects). Elevated national debt levels also make debt stimulus less effective; the economy now requires six times the amount of credit to produce the same unit of growth as it did a decade earlier.

Balance of power

Investors should take note of China’s current account number, which measures the country’s consumption relative to how much the economy earns. China has a current account surplus, which means it exports more goods than it imports. This balance of payments is among the contentious issues not just between the US and China, but also the rest of the world and Beijing. More countries want China to import more goods and services from the outside world – and with domestic consumption rising, China has begun to oblige them.

Since topping out near 10% of GDP in 2007, China’s current account surplus is now less than 1% of GDP, according to the International Monetary Fund. While the current account surplus falls as China’s corporations pay for services like royalties or licensing, overseas tourism is also another major factor.

In 2017, more than 130 million Chinese travelers went overseas, spending an estimated $250 billion on their trips. Early estimates suggest that nearly 150 million Chinese travelers went overseas in 2018. With the RMB depreciating against most major currencies, including 6% against the USD, this would suggest that households remain relatively optimistic about their economic circumstances. At the very least, they don’t seem to worry too much about foreign exchange rates when traveling abroad.

What car sales reveal about a changing China

Besides more Chinese traveling abroad, investors need to consider those citizens’ changing consumption patterns at home.

China’s new car sales fell 2.8% in 2018 – but secondhand vehicle sales jumped 11.5% to 13.8 million units, according to the China Automobile Dealers Association. The ratio of secondhand vehicles to new models stood at 49.1%, a 6-percentage-point gain over 43% in 2017. This comes as a surprise: In China, cars not only reflect an individual’s social status, and Chinese culture traditionally discourages ownership of previously owned goods.

But the rise of secondhand cars is also important from an economic data perspective. By definition, used car sales are not included in GDP figures, since no new additional economic value had been created. Only spillover effects (replacement parts or services) are included, suggesting that while the economy records the 2.8% drop in new car sales, it only recognizes a portion of the 11.5% increase in secondhand cars.

What you need to know about China’s economic shift

While economic indicators continue to reflect general softness in the overall economy, China is consuming more relative to what it earns. Unfortunately for domestic companies, more consumers are changing the way they buy goods, as the spike in secondhand car sales suggests.

Analysts expect the current account surplus to eventually turn into a current account deficit, which normally leaves a currency more susceptible to depreciation pressure. While this would make local goods more attractive relative to foreign products, the rise in foreign travel despite a stronger dollar suggests that for many Chinese households, foreign exchange is not a significant reason to alter consumption habits.

Should the economy further soften, Beijing is expected to cut taxes and lower tariffs to incentives more consumption at home. But as Chinese consumers begin to value experiences over possessions, it may be harder for domestic companies to meet this demand. Chinese consumers are spending more – just not on new products in China.

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