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Why is the Chinese economy slowing down?

China’s economy appears to be slowing faster than expected at the start of the fourth quarter, a bad omen for growth early next year when the full force of the trade war with the United States comes to bear.

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This situation is likely to spur Beijing to introduce new measures to support growth, analysts said.

The government will try to avoid returning to its battle-tested plan of large-scale monetary and fiscal stimulus so as not to exacerbate the country’s already huge stock of debt, but it may have no choice but to move some way in that direction to stabilize growth.

Business sentiment in both the manufacturing and non-manufacturing sectors was weaker than expected in October, led by sharp declines in export demand, according to the official purchasing managers’ index published on Wednesday by the National Bureau of Statistics and the China Federation of Logistics and Purchasing.

The figures were the first gauges of the trade war’s impact since the U.S. levied 10 percent tariffs on $200 billion worth of Chinese goods in late September.

The manufacturing sentiment index dropped to 50.2 in October, from 50.8 a month earlier.

The reading, which was its lowest in more than two years and barely above the 50 point line that separates expansion from contraction in the sector, suggests the possibility of contraction in November as the U.S. tariffs take effect.

That situation could worsen in January, when the tariff on the $200 billion of Chinese imports is set to rise to 25 percent.

It might also be exacerbated by the “front loading” behavior of many Chinese exporters — boosting production and shipments now to fill orders for early next year before the scheduled tariff rate increase.

Production and unemployment among export manufacturers are at risk of falling sharply from January due to lack of orders to fill.

New export orders contracted for the fifth month in a row in October, to 46.9 from 48 in September.

Imports also contracted for a fourth straight month, indicating weakening demand within China, while the decline in manufacturing employment accelerated.

Non-manufacturing activity, dominated by the service sector, also slowed in October, with the index dropping a full point to 53.9.

While the index still indicates a healthy level of activity, the size of the drop could be a sign of a sharp slowdown ahead.

Indeed, the contraction in service sector export orders seen in September accelerated sharply in October, falling a further two points to 47.8.

The October data also reinforce the picture that small- and medium-sized companies are struggling, with indices for both groups falling further into contraction.

In contract, the index for large companies fell but remained in positive territory.

“The economic conditions facing China’s private sector are much worse than the headline figure suggests, in our view,” analysts at ANZ said in a report. “The October PMIs for mid-sized and smaller sized companies fell to 47.7 and 49.8, respectively.”

“So we expect the Caixin PMI to have already fallen into the contractionary zone,” the report said.

The Caixin PMI data better reflects sentiment in smaller, usually private sector firms.

Analysts said that a faster than expected economic slowdown this year could be compounded early next year by a lack of new orders and higher U.S. tariffs, prompting further action by the government to prop up growth.

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“We expect a worse growth slowdown in spring 2019 for several reasons [especially after export front loading],” said Ting Lu, chief China economist at Nomura Global Market Research.

“Beijing’s policy focus so far has been on containing a credit freeze. If our more cautious views prove to be valid, growth is likely to slow to such a worrying pace in spring 2019 that Beijing may have to greatly ramp-up its easing/stimulus measures.”

The economic forecasts do not take into account the possibility of a large escalation of the trade war.

U.S. President Donald Trump said again on Monday that tariffs on an additional $267 billion worth of Chinese imports — which would equate to sanctions on virtually all Chinese goods — were “ready to go” if there was no trade progress.

He said he expected the trade war to result in a “great deal” for the U.S., but did not say how and when that would happen.

Analysts warned that while the direct impact of U.S. tariffs on the Chinese economy is limited, the negative impact on business and consumer sentiment, and so on the economic outlook, could be much larger.

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Steven Cochrane, the chief Asia-Pacific economist with Moody’s Analytics, said in an interview that additional tariffs would have an outsize impact.

“There would be much more uncertainty that would tend to slow the pace of investment and consumption,” he said.

“Consumers are [already] feeling uncertain about next year, so they are going to pull back.”

In retaliation, China might implement qualitative measures, such as more aggressive inspections of imports from the U.S., creating stiffer visa requirements for visiting American workers, slowing regulatory approval for U.S. companies operating in China or targeting service imports from the U.S., including restricting the enrollment of Chinese students at American universities.

In a research note released last week, Cochrane estimated that if a 25 percent tariff were imposed on all China-U.S. trade and Beijing applied qualitative countermeasures, China’s gross domestic product growth would fall by 1.2 percentage points to 5.2 percent in 2019 and the Chinese stock market would fall by 9.4 percent.

The U.S. is reportedly preparing to impose the next round of tariffs on the $267 billion in Chinese goods in early December if Trump’s scheduled meeting with Chinese President Xi Jinping at the G-20 summit in late November produces no progress.

If true, and given the 60-day comments period that would start when the tariffs are announced, this would mean that the new tariffs would be implemented in early to mid-February, during or just after Lunar New Year.

Like Christmas in the West, the celebration is the largest instance of consumer spending during the year, so any fall in sentiment caused by the introduction of the new tariffs could have a very negative effect on China’s economy.

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Business sentiment in both the manufacturing and non-manufacturing sectors was weaker than expected in October, led by sharp declines in export demand, according to the official purchasing managers’ index.

The figures were the first gauges of the trade war’s impact since the U.S. levied 10 percent tariffs on $200 billion worth of Chinese goods in late September.

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