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As the Beijing-Washington tariff battle escalates, China’s economic growth has slowed slightly in the second quarter ending in June, raising concerns about the country’s economic outlook.

The world’s second-largest economy expanded by 6.7% over a year earlier, down a tick from the previous quarter’s 6.8%, the government reported Monday.

Despite the tick lower in Q2, Krishen Rangasamy, managing director and senior economist at National Bank, said in a report that China’s GDP growth remains strong and on track to hit the government’s annual target of 6.5% growth.

Forecasters had expected a slowdown since Beijing tightened lending controls last year to rein in surging debt. Key drivers of growth—including spending on construction and other investments—were weakening even before the dispute with Washington erupted.

Still, Mao Shengyong, a spokesman for the National Bureau of Statistics, said that “uncertainties of the external environment are mounting.”

Tariffs could make for tough times

Chinese leaders have expressed confidence their US$12-trillion-a-year economy can survive the tariff war with U.S. President Donald Trump. Beijing is resisting American pressure to change industrial policies Washington says are based on stealing or pressuring foreign companies to hand over technology, and might threaten U.S. industrial leadership.

But forecasters said the downturn is likely to deepen as Beijing tightens financial controls and trade tensions worsen.

“There are risks that Chinese growth will slow more abruptly,” Citigroup economists said in a report.

Washington imposed an additional 25% tariff on US$34 billion of Chinese goods on July 6. Beijing retaliated with similar penalties on the same amount of U.S. imports. Washington fired back last week with a threat of 10% tariffs on an additional US$200 billion list of goods, effective in September or later. In response to last week’s tariffs, China filed a World Trade Organization challenge Monday.

Though trade contributes less to China’s economic growth than it did a decade ago, it still supports millions of jobs. And, though Trump’s first tariff hike didn’t take effect until the current quarter, exporters say American orders started to fall off as early as April.

More broadly, anxiety about tariffs “is already dampening business confidence and delaying investment,” said Louis Kuijs of Oxford Economics in a report.

Unless the two sides restart negotiations, “the conflict will escalate further, with major economic implications for themselves and the global economy,” said Kuijs.

Investing in a changing economy

Of potentially greater concern than trade, however, is “slowing domestic demand within China’s economy,” said Tom Rafferty of the Economist Intelligence Unit in a report.

China is the number one trading partner for its Asian neighbours and buys oil, iron ore and other raw materials from Australia, Brazil and elsewhere. Chinese consumers are an increasingly important market for food, clothes, electronics and other goods.

Chinese leaders are in the midst of a marathon effort to encourage self-sustaining growth driven by domestic consumption and to reduce reliance on exports and investment.

Investment in factories, housing and other fixed assets decelerated in the latest quarter, down 1.5 percentage points from the first quarter.

Consumption and government spending accounted for almost 80% of Q2 growth, said the National Bank report. “With growth tilting toward domestic demand, China’s vulnerability to a potential trade war is arguably diminishing.”

The report further said that Chinese goods exports to the U.S. now account for just 3.3% of China’s GDP, the lowest in at least 20 years.

China’s retail spending in June rose by 9% over a year earlier, a half-percentage point higher than in May. The increase was driven by rapid growth in the sales of higher-end consumer goods such as cosmetics and audio-video equipment.

Beijing has responded to previous downturns by flooding the state-dominated economy with credit. But that has swelled debt, prompting concerns about risks to the banking system. The ruling Communist Party has made controlling financial risks a priority this year, suggesting it will resist easing lending controls.

While financial stability remains a key risk for China in the medium term, says BlackRock’s midyear global outlook report, its near-term outlook is resilient as domestic consumption increases and as investment represents a decreasing share of economic activity.

However, the firm warns: “All of this comes amid reform progress, financial de-risking and slower credit growth. Getting this transition right is tricky, and any missteps could lead to bursts of volatility in Chinese asset prices.”

For now, the firm expects solid corporate earnings based on guidance from Chinese firms and language used in global earnings calls.

Some forecasters say that, if threatened tariff hikes by both sides are fully carried out, China’s 2019 growth could be cut by up to 0.3 percentage points.

Mao, the statistics bureau spokesman, declined to say how much the dispute might hurt Chinese economic growth.

“But generally speaking, trade frictions unilaterally started by U.S. will have an impact on the economy of both countries,” Mao said.

For more details, read the reports from National Bank and BlackRock.

Originally published on Advisor.ca
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