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Some in the financial press argue this time is different since the so-called trade war with the U.S. is supposedly causing the slowdown. It is possible looming tariffs pulled some activity forward as firms sought to ship merchandise before the duties took effect, resulting in even slower growth in their wake. December Chinese exports’ contracting 4.4 per cent y/y after growing at a double-digit rate for most of 2018 could reflect this activity.[iii] Yet even if this proves to be the start of a trend, it doesn’t necessarily mean the hard landing has arrived. Chinese trade data were negative for much of 2016, yet GDP growth slowed only gradually and was in line with the government’s official target.[iv]

Rather than the trade tiff, we think China’s slowdown is more related to the government’s efforts to get control over the shadow banking realm last year. Shadow banking refers to borrowing and lending that occur outside of the traditional banking system. Whilst shadow banking exists worldwide, due to Chinese laws prohibiting individual savers from purchasing debt instruments directly, as well as official loan quotas that govern how much credit large banks can extend, a large shadow banking sector has emerged. Last year, policymakers’ statements and actions indicate they prioritized moving activity from the shadow banking sector to traditional financial markets. However, our analysis indicates this disproportionately affected small to medium-sized businesses, which major state-run banks historically shunned due to loan quotas. To soften the blow, regulators have stepped in with stimulus measures. China’s central bank cut the reserve requirement ratio (the amount banks must hold in reserve to back loans) four times last year and again in January 2019, incentivizing banks to lend. The government also lowered taxes for individuals and boosted local infrastructure investment. However, these measures’ impacts tend to hit at a lag, so their benefits likely won’t show up in the data immediately. We also don’t know how effective they will be. It is possible rules adopted as part of the shadow banking crackdown end up preventing money from going to the smaller firms that were shut out last year.