May 27, 2020

What Happened

The National People’s Congress (NPC) is by far the most critical policy meeting in China. This year’s conference had to be delayed by almost three months due to the COVID-19 outbreak. At this annual gathering of political and military leadership, the country usually sets targets for economic variables. Also, it discloses foreign policy directives that could provide hints to outside observers.

No More GDP Targeting

Before COVID-19, the expectation for China’s 2020 GDP growth rate was around 6%. Currently, the consensus estimate is 1.8% (Figure 1). During the first quarter of 2020, the Chinese economy contracted by 6.8%, which was the first economic contraction since the 1970s. At the NPC, Li Keqiang, Premier of the State Council, announced that, due to ongoing global economic uncertainty, China will eliminate economic growth targets this year, which was mostly expected and also welcomed. Eliminating rigid economic growth rate targets could ease some concerns regarding the Chinese economic numbers’ validity and allow the country to invest in the productive parts of the economy instead of achieving a pre-defined growth rate objective.

Even with no official GDP target, China announced that it would increase its military spending by 6.6% in 2020, showing that it is determined to spend more on its military even though the economy is slowing down considerably. The country’s fiscal deficit will be a percentage point higher this year at 3.6% of GDP, indicating much less deficit spending versus many other countries battling a deep economic slowdown in 2020.

Before COVID-19, consensus GDP growth rate estimates for China were around 6% for 2020.

Even with COVID-19’s impact, the Chinese economy has the potential for economic growth in 2020.

Hong Kong and Taiwan

At the NPC, China’s ruling Communist Party set a controversial national security law for Hong Kong into motion. At the heart of the issue is that the proposed law would allow protesters to be punished more severely than in the past. China would be able to amend the measure to Hong Kong’s constitution called the Basic Law, effectively bypassing local lawmakers in the city.

This year, Hong Kong stood out with its successful fight against the spread of the coronavirus. The lawmakers in the city were working on an economic recovery plan that included multiple fiscal stimulus packages. Unfortunately, this proposal will probably trigger more protests, leading to civil disruption and causing delays in the anticipated economic recovery. More importantly, Hong Kong’s status as a financial hub in the region becomes questionable, given increased legal uncertainty due to potential conflicts with previously signed international treaties.

To further complicate the matter, in reaction to the proposed security law, US lawmakers introduced a bill in the US Senate that would sanction Chinese Communist Party officials enforcing the national security laws in Hong Kong. If passed, this new law would also penalize banks that do business with any entity enforcing the law. This geopolitical maneuvering raises the risk of future unintended policy mistakes.

The geopolitical specter is pushed further into the international community’s view by China’s handling of its desire to reunify with Taiwan. In Premier Li’s speech, what he did not say became more important than what he did say about the Taiwan issue. In the past, China always highlighted that the country is pursuing a “peaceful” reunification with Taiwan. This time, Premier Li’s speech dropped the word “peaceful”, highlighting additional geopolitical risks.

Our Take

On July 1, 1997, China pledged to allow the citizens of Hong Kong to live under “one country, two systems” until July 1, 2047. Until then, it is in China’s best interest to have Hong Kong remain the premier financial services center in Asia and China’s gateway to foreign investment and technology. One would expect that China, with over 4000 years of history, will have the patience to wait another 27 years to take full control of Hong Kong without breaching any international treaties or compromising the city’s value.

Hong Kong and Taiwan are the cards China likes to play whenever it faces heightened international scrutiny. A similar version of the security law was introduced in 2003 with no success in the end. This time, it could take a considerably longer time for China to ditch its efforts due to external pressure it is feeling over COVID-19-related accusations by the international community.

Bottom Line

China dropping its strict, target-based GDP growth rates is a step in the right direction. With this measure, productive areas of China’s economy could receive additional attention, eventually improving the country’s long-term sustainable growth potential.

The pro-democracy movement in Hong Kong was expected to have a strong reaction against the proposed security law, and the city’s already dire economic situation due to the COVID-19 pandemic is expected to get worse. Tensions between Beijing and Washington are likely to open another chapter that could further damage the already strained relationship between China and the US. Geopolitical tensions between the two countries could escalate further as we get closer to the November election in the US. We continue to recommend underweight positioning in Emerging Market Equities where direct exposure to China is over 40% of the index.

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CN2020-1156 EXP12-2020