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China's growth slowdown may get a temporary reprieve in 2019

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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Eaton Vance disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Eaton Vance are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Eaton Vance fund. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results.

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      By Emerging Markets Debt Team, Eaton Vance Management

      Boston - The Eaton Vance Global Income team believes that the best approach to emerging-market investing is through the proprietary country-level macroeconomic and political research of our investment professionals. An important part of our process is the annual research retreat that brings together analysts and portfolio managers in Eaton Vance's Boston headquarters, and this year, China's economy was one of the key topics.

      China's growth has slowed from 9.3% in 2011 to 6.9% projected in 2018 by the International Monetary Fund (IMF), despite government stimulus in the form of tax cuts, lower bank reserve requirements, infrastructure investments, and a rollback of regulations designed to restrain "shadow" banks and local government borrowing. Authorities have also exhorted financial institutions to "become more active and take greater political responsibility" to help spur lending to the beleaguered private sector.

      However, such measures and guidance so far have shown few signs of success. Key economic indicators such as retail sales, fixed investment, money growth and bank asset growth have all fallen in 2018. Broad credit — including bank loans, bonds and nonbank credit — grew at its slowest annual pace on record, at 11.1%, according to central bank data released in November.

      China's slowdown was well underway before the U.S. tariffs that were introduced in July and September. Clearly, the prospect of an escalating trade war has deepened the market's pessimism about the Chinese economy. The consensus view is for growth to fall by about 0.2% for the next few years.

      Nevertheless, we believe that the Chinese economy could surprise on the upside in 2019 - assuming that the U.S. and China can reach some kind of accommodation on trade. We are starting to see some indication that the stimulus is starting to have an impact - for example, statistics released last week suggest that fixed asset investment has bottomed out. This follows issuance of about RMB 1.3 billion in infrastructure bonds offered between last August and October. New measures set to go into effect in January, including additional personal tax deductions, should also help the cause.

      To put this in perspective, China engaged in massive leveraging in the wake of the global financial crisis. In recent years, authorities tried to moderate that debt buildup, with measures such as cracking down on shadow lending. The continued slowdown suggests that the toll taken by deleveraging may have overshot the goal. The most recent efforts by the government have been to reverse course through its stimulus. We believe it now may be overshooting on the upside - it is very hard to manage an economy of 1.4 billion people "to plan."

      Beyond 2019, the problem of slower growth should once again become the headline concern, at around 5.6% by 2023, according to IMF projections. China's fundamental economic and demographic challenges remain. Leverage growth must slow or debt service costs will likely become unsustainable. Investment growth is still too high, and must be balanced by greater consumption, at the same time population growth is peaking and dependency ratios are rising.

      Bottom line: The lagged effects of China's stimulus may finally show in 2019, and given the gloomy consensus, even mid-to-high 6% growth would constitute a surprise to the market. Longer term, the challenges confronting the world's second-largest economy are likely to continue as a drag on growth.