China ending 2018 with only moderate slowdown but the prospect is challenging

China’s business sentiment is clearly very negative, especially in the manufacturing sector, where the PMI dropped below 50 in Q4 2018, the cut-off point separating expansion from recession. However, China ended the year with only a minor slowdown at 6.4% in Q4 2018, thanks to the resilient fixed asset investment, especially in the upstream industrial sector. Both exports and imports declined significantly in December 2018, but the trade surplus has recently increased, contrary to what one had expected, especially after the China International Import Expo held in Shanghai. On exchange rate, no matter how negative the sentiment is, both a less hawkish FED and a more positive expectation regarding trade war negotiations are behind the RMB rally against USD since mid-November: surging from 6.96 to 6.76 in early January. Despite the seemingly better-than-expected growth, China’s economic outlook is still worrisome. The reason is not only the decelerated consumption, but also the deflationary pressure from rapidly decelerating producer prices. As exemplified in 2015, this could weigh on China’s corporate profitability, especially for the upstream sectors. And the risk aversion sentiment could negatively affect the funding ability for corporates, especially for the private sector. Against this backdrop, the Chinese government has no choice but to take a more expansionary policy stance to avoid a hard landing. The recent movement suggests more administrative measures , including the introduction of Credit Risk Mitigation Warrant (CRMW), targeted medium-term lending facility (TMLF), establishment of government-led relief funds, and directed quota on targeted loans. We also expect more to come on fiscal policy beyond the rapid increase in the general budget deficit in H2 2018. With higher issuance of local government special bonds, public investment is likely to surge in 2019, particularly in infrastructure projects. All in all, 2018 has ended with only moderate slowdown but 2019 could be worse if there is no stimulus. China will use fiscal measures and administrative measures to shore up business confidence to promote economic growth. As such, we expect China to experience moderate and smooth slowdown to 6.3% in 2019.