Many economic variables remain for China with ongoing US trade tensions

04 April 2019 5 min. read
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Against the back-drop of ongoing US-China trade tensions, with talks resuming this week, a report from global management firm McKinsey & Company examines the short-term economic landscape in China.

Recent years have seen an increasingly hostile trade relationship between major global powers. The effect has been uncertainty and a potential slowdown in the global economy, and tariffs between the US and China in particular have resulted in uncertainties for businesses globally. A recent analysis from McKinsey & Company explores possible impacts on businesses.

To better understand possible changes for the Chinese market, including changes to how global businesses operate in China and the wider impact of likely regulations may have on future activity, the ‘What can we expect in China in 2019?’ McKinsey report considers a range of major themes likely to affect consumers and businesses in China over the coming year.

With the trading relationship between the US and China recently souring, tariffs have been enacted by both countries on their respective goods. The effect of tariffs remains a key unknown, with negotiations to offset further tariffs ongoing. Yet for businesses, one consequence for the coming year is uncertainty, the effect of which could result in more measured decision-making.US trade with China and the impact of tariffsBesides the tariffs, the US has deployed a raft of measures to prevent various harms to its businesses in China. These range from measures to protect intellectual property to those focused on reducing barriers to the operation of businesses within China. The firm notes that negotiations may see tariffs rolled back – pending structural changes, many of which would benefit foreign businesses operating in China.

The ultimate effect of a further ratcheting up of tariffs – a further 25% is planned on $200 billion of goods from China if no deal is reached – also remains unclear. As it stands, around 20% of Chinese factory output is destined for the US. However, many of the larger companies operate across multiple jurisdictions, with factories outside of China in some instances able to pick up US destined products and other production tasked shifted to China – resulting in some additional operating cost but not much capital expenditure.

Some production is also being shifted out of China, as the country itself shifts focus, into new manufacturing bases in Southeast and South Asian countries. Samsung for instance has moved some of its operations to Vietnam, while Li & Fung’s textiles has moved operations to Bangladesh. The firm notes however, that given the strength of the Chinese supply chain, such moves are small relative to the continued dominance of Chinese manufacturing.Shifts in China’s inward and outward international exposureOne effect of the US government’s increased focus on limiting intellectual property exposure to China is more stringent rules around access – to plans and products as well as business partnerships and talent. The report notes this could see the Chinese and US arms of businesses split up in the future into distinct legal entities, with more specific “localised” products and services to meet market needs as well as new regulatory requirements.

Domestic markets also face a number of headwinds, reflecting wider structural difficulties in the market resulting from borrowing against relatively high share-values. The money, which came from both official and shadow bank sources, was often not put to productive use, which now means many companies have loans that are effectively underwater; estimated it at around $1.3 trillion or 10% of the market capitalisation. However, the effect of this is likely to see both state and wider business intervention to bail-out effected companies, whose fundamentals remain relatively solid.Premium product trade-up in China compared to the UKStill, the study found that consumers will remain the main driver of the Chinese growth story, generating 78% of economic growth. Here, consumers remain relatively resilient to the effect of US tariffs, with only modest declines in spending – consumers having seen their incomes increase by 8% over the past nine months. The government has also announced tax cuts – equivalent to a year’s pay for the median household.

Consumers in China are also continuing to shift their purchasing to higher quality products and services, as incomes increase. Trading up is taking place across most product types, with spirits and wine seeing the highest level of shift followed by cosmetics and hair products. In developed markets, meanwhile, consumers are opting to trade down – for instance, in the UK, the firm notes there is a net negative trend in most product categories for lower quality/priced goods.

That consumers remain confident and willing to grow their spending is however essential if China is to achieve anything close to 6 percent growth in 2019, states the report, concluding; “2019 is a year to remain highly alert to signals on where the economy is headed, most critically for being prepared for a wide range of outcomes and being bold when it comes to taking action.”