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China—Trade war complicates economic rebalancing

Beijing has actively steered the economy towards services and consumption at the expense of unsustainable investment-driven growth over the last few years (Chart). Policymakers have also increased regulation to cool the overheated real estate sector, which accounts for 20% of GDP, and are cracking down on financial risks and debt. This was always expected to slow growth over time. But robust exports allowed Beijing the necessary headroom for reform by ensuring the economy was strong enough to support jobs and wages growth.

The ongoing trade fracas between China and the US, highlighted by the latest round of trade tariffs, is contributing to slowing economic momentum. High frequency production, investment and export data all softened in August. In response, policymakers have introduced fiscal stimulus via tax cuts, encouraged local governments to fund more infrastructure investment, and eased financial conditions for firms.

The size of this fiscal stimulus is much lower than previous stimuli, including the post-GFC injection. Still, greater accumulation of local government debt tests Beijing’s commitment to address China’s large debt burden (>250% of GDP in 2017). It also signals that Beijing may be willing to revert to its investment-driven growth model should the outlook deteriorate, complicating transition toward a consumer-based economy.