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Slower growth ahead, more stimulus in 2017

Although Chinese third quarter GDP grew 6.7% year-on-year, in line with expectations, there are a few reasons to believe growth will decelerate during the rest of 2016. The authorities are cracking down on frothy housing markets in some parts of the country, the government faces fiscal constraints and against the backdrop of a property market bubble and building currency depreciation pressure, the central bank is likely to be reluctant to ease policy to support growth if it does slow.

One final reason to expect something of a slowdown in the final quarter is simply that the government can afford it. GDP growth so far this year has been comfortably above the 6.5% target, such that even 6% growth in the final quarter would see the government deliver.

Consequently, policymakers may prefer to keep their remaining powder dry in the fourth quarter, saving their firepower for 2017 to ensure strong growth ahead of the 19th Party Congress. Statements from President Xi on the importance of fiscal policy, and on the importance of state control of SOEs (state-owned enterprises), suggest to us that market reforms are taking a definite back seat to growth for the time being, regardless of the long term costs.

Growth should largely meet its target this year and in 2017, but the longer term picture is deteriorating.

Leveraging to the hilt

On the continued growth of credit, as evidenced in this quarter’s figures, we believe the key question is how the debt build up will manifest. Will China blow up and suffer a hard landing, or will it experience something more akin to Japan – decades of very slow growth and an economy replete with zombie firms and banks.

We think at this point it is too early to say as we don’t know what the policy reaction will be when the tipping point comes. That said, it should be noted that China will still enjoy higher growth potential than Japan did at the time of its crisis, which mitigates the risk somewhat.

We should get a clearer idea after the 19th Party Congress in November next year, when the policy objectives for the next five years will be set.