Feb 2020

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Steady as she goes

Source: Asia Insurance Review | Aug 2019

Euler Hermes has predicted that China’s economic growth is set to slow but remain resilient at +6.3% in 2019 (from +6.5% in 2018). With a slower growth in global trade and private consumption in the first half of 2019, Euler Hermes expects China’s activity growth to stabilise in the second half of the year. This stabilisation will stem from the acceleration of domestic demand, led by expansionary policies say Euler HermesAlexis Garatti and Christopher Shortell.
The Chinese government announced a fiscal package of c.5% GDP in March 2019. Financial authorities also revealed a wide range of policies to ease financing conditions for the private sector. This includes measures to increase liquidity in the financial system (e.g. reserve requirement ratio cuts), boost banks’ capital, support the development of non-shadow banking sources of financing (e.g. equity, corporates bonds) and prompt banks to lend to the private sector.
Impact of trade war on the Chinese economy
US-China trade tensions have escalated with both countries raising tariffs against each other on 10 May 2019: 25% on $200bn of imports from China in the US; 5% to 25% tariffs on $60bn of imports from the US in China. Against this background, policy support is set to increase. Euler Hermes has predicted three reserve requirement ration (RRR) cuts of 100bps each and two policy rate cuts of 25bps by the end of this year.
Euler Hermes predicts the CNY converging to CNY7 to $1 by end of 2019 (against 6.7 end Q1) as authorities step up easing measures to absorb tariff costs, and capital outflows intensify due to higher risk aversion. 
This movement in the CNY is likely to impact global equity prices further as it could be interpreted as an uncooperative reaction to US tariffs. The 10-year Chinese government bond at 3.1% (after 3.7% in 2018), reflects monetary interventions and a rush of domestic investors to get less risky assets. 
Mr Garatti said, “We are rather prudent on Chinese equities. While it is likely that the national team (of state-backed funds) and the authorities will intervene to prop up the market, we see limited room for gains as the external demand outlook darkens. Higher risks weighing on the global equity market could materialise in higher volatility as the Q12019 rebound was artificially driven by an easing of monetary policies (without links with fundamentals) and a factor-in of a positive outcome in US China negotiations (not observed yet).”
According to Euler Hermes’ estimates, trade tensions with the US are expected to affect GDP growth rate of China negatively by -0.3pp at a two-year horizon (including 2019). If the US were to implement additional tariffs on $325bn imports from China and $200bn on car imports, such escalation would means a trade war scenario in our trade-game, trade-feud, trade-war decomposition of universes. A trade war would mean a loss of 1 percentage point in China’s GDP growth over two years. For now, the G20 summit in Japan seems to indicate a pause in the trade dispute. However, Euler Hermes remains in the trade feud scenario because of prior hikes in US tariffs. Uncertainty on trade relations between US and China continues weighing on the global investment cycle. 
MSCI Index and forward EPS growth
Business environment: Changing the rules of the game
The business environment in China is improving. China jumped to the 46th rank in the World Bank Doing Business survey in 2018 (from 78th in the previous edition). This progress reflects improvement in a wide array of subcomponents ranging from procedures for starting a business to measures to improve electricity access and get construction permits. Looking ahead, signs of further improvement are building up. Since last year, the authorities have intimated a range of policies, with the objectives to: 
  • Create a pro-private businesses environment (tax cuts, targeted lending to private companies)
  • Facilitate trade with tariff cuts (e.g. on the automotive sector, consumer goods) 
  • Accelerate the country’s financial opening with reduced barriers to foreign investors
Drivers for the economy in 2020
The drivers in the Chinese economy relate to ongoing fiscal and monetary stimuli. Domestic demand has yet to respond positively to the two impulses. As regards the fiscal stimulus, its important size (5% of GDP) will represent a safety net for the economy, albeit with a lower multiplier effect compared with prior episodes of stabilisation. On the monetary side, further liquidity injections and RRR cuts will take place in order to provide another impulse to social financing, while at the same time assuaging the fears of the market over the stability of the banking system. 
How the Chinese economy impacts APAC
Any shock in the Chinese economy has very important repercussions for the rest of Asia because of densely integrated supply chains and important trade connections. In emerging Asia, counter-cyclical policies will help keep growth at a decent pace. Inflationary pressures have decreased and there is more room to ease monetary policy, the second element of Euler Hermes’ Big Switch scenario (please refer to URL link below). India already begun with a policy rate cut of 25bps. Euler Hermes expects some central banks in the region to follow the same path (Malaysia, Indonesia by -25bps) by the end of this year. In advanced economies in the region (e.g. South Korea, Taiwan, Hong Kong, Australia), fiscal policies will be a driver for growth.
Trade structure by partner (WITS Database 2017)
Prediction on China’s credit market, insolvency and defaults trends
China’s industrial profits decreased by -3.3% in Q12019. Debt is on the rise as authorities are increasing accommodative measures (bank credit to private sector up +13% y-o-y in Q1). Looking ahead, Euler Hermes foresees a rise of credit risk in China due to a poor sales outlook for exporters and the rise in debt. In addition, there will be room for growth for domestic demand and policy-led companies (infrastructure and private consumption-related companies).
Euler Hermes Hong Kong head of macroeconomics Alexis Garatti said, “All in all, we expect the Chinese economy to grow by 6.3 % in 2019 compared with 6.5% in 2018. We expect insolvencies to rise by 20% in China in 2019 as a result of economic growth deceleration as well as mirroring the continuation of reining-in policies related to over-capacities and credit.”
Trade structure by product (2016 WTO Trade Profiles)
Euler Hermes China CEO Christopher Shortell said, “As a result of current economic conditions and the US-China trade disputes, we do expect an increase in overdues and insolvencies over the next 12 months. Euler Hermes China will work closely with its partners to help companies monitor and manage credit risks, to have the confidence to be bold and grow their business profitably. A 
Mr Christopher Shortell is CEO of Euler Hermes China. Mr Alexis Garatti is head of macroeconomics at Euler Hermes, Hong Kong.
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