Apple’s announcement that sales will be weaker than expected was largely blamed on slower growth in China. Indeed, Chinese growth has been decelerating for several years to a reported 6.5%, although many suspect that the official numbers are overstated. Nonetheless, China does have levers to pull to maintain its expansion.
The metaphorical phrase “when the U.S. economy sneezes, the world catches a cold,” can also be applied to China. But judging by the global equity markets reaction, maybe it should be changed to “when China sneezes, the world catches pneumonia.” While China accounts for only 15% of global GDP compared to 24% for the U.S., China’s economy grows faster, and its $1 trillion contribution to global economic growth in 2017 exceeds the $766 billion attributed to the U.S.
Of course, most of China’s growth to date has been internally focused on infrastructure investment, as reflected in the country’s roughly 50% absorption of global supplies of mining products like nickel, copper and aluminum. But economic growth eventually brings higher household income, and consumer spending evolves to account for a larger proportion of the overall economy. Those newly flush China consumers will seek not only to buy locally, but also will increasingly demand products from other countries.
The importance of China’s growing consumer class for the health of the global economy was highlighted most recently when, last week, Apple lowered its December quarter revenue outlook and cited disappointing China sales. While Apple’s Greater China sales ramped impressively from $12.7 billion in 2011 to a 2015 peak of $58.7 billion, it has fallen since to $44.7 billion in 2017, and its recent recovery to $51.9 billion in FY18 still falls short of the 2015 high-water mark. Other major U.S. brands and companies to have also benefited from a healthy China include General Motors, Boeing, Starbucks, and Pizza Hut, to name a few, but the impact goes far beyond these. The country’s importance is becoming more pervasive, not only in its influence in Asia, Africa, and Europe, but also in the U.S. where companies in multiple industries show China as a key customer. These include aircraft builders, semiconductor makers, plastics companies, specialty chemical suppliers, gas suppliers, machinery manufacturers, and farmers. While China’s overall share of U.S. exports is only 8%, many companies have much higher exposure and will suffer if China’s economic engine stalls.
Clearly, the market notices when China reports economic deceleration, and it recently displayed outright angst when China’s December manufacturing report dipped into contraction territory, registering the lowest reading since March 2016. The Purchasing Managers Index revealed broad-based deterioration in orders, production, imports, and inventories. Small firm manufacturing weakness was particularly distressing since this has been a focus for stimulus by policy makers.
It’s important to remember that much of this deceleration has been self-administered, and may already be heading for a reversal. Moreover, policy makers recognize that the situation is aggravated by looming trade risks. They are very sensitive to an overly rapid slowdown and have already unleashed several measures to stabilize growth. Massive stimulus, which was provided after the Global Financial Crisis, will likely be avoided, however, since this contributed to the country’s debt overhang, overcapacity, and other problems like air quality. Being a relatively rich country, fortunately, places other resources and policy tools at China’s disposal. One such tool is a tax cut. A recent statement by China’s Director of the State Administration of Taxation projected that the government’s planned tax and fee breaks could amount to over CNY1 trillion, or about $145 billion, in 2019. This is only slightly smaller than the 2017 U.S. tax cut which amounted to approximately $168 billion in reduced 2018 tax revenues. The planned breaks include reductions in the value-added tax, corporate income tax, and individual income tax, and also multiple tax exemptions for small firms and technology start-ups. These incentives should be significant, but are only expected to push the country’s deficit from 2.6% of GDP up to 3.0%, according to IHS Global Insight. Additionally, the latest politburo meeting emphasized the need for further stimulus by easing credit, accelerating money growth, and providing export incentives. These steps should improve consumer and business confidence and lead to increased private consumption and reverse the negative trend of China’s economic data in 2019. While China growth may be settling into a slower, longer-term trajectory, we doubt the Chinese economy is heading for a recession in the visible future.