Goldman Sachs Economic Outlook Highlights Potential Downside Risks for China Amid Trade Tariffs and Credit Expansion

Exhibit 45: China Economic Activity Measures Actual growth is likely lower than official figures. % YoY, 3-Month Moving Average 34.8 Real GDP Growth ’ | Ss Emerging Advisors Group China Activity Index Goldman Sachs China Activity Indicator 2000 2002 2004 2006 2008 2010 2012 2014 2016 Data through 03 2016. Source: Investment Strategy Group, Emerging Advisors Group, Goldman Sachs Global Investment Research. both China and the US, such as Korea, Taiwan and Malaysia, would be particularly vulnerable. While the net effect of these competing forces is positive in our base case, the risks are tilted to the downside. China China continues to drive its economy with one foot on the gas pedal and the other on the brake. Consider that the government reached its official GDP growth target of 6.5-7% last year only by increasing public spending and allowing rampant credit growth. But these measures also exacerbated real estate bubble concerns and hastened capital outflows, forcing the government to apply the brakes through new restrictions within the property market and more stringent capital controls. This focus on dual-footed driving has also come at the expense of much-needed structural reforms. As a result, China continues to suffer from considerable excess capacity in industrial sectors, such as steel and coal, while its financial sector risks have increased. Even so, we expect this approach to continue in 2017. Structural reforms are likely to stay on the back burner because China’s leaders will not risk slower growth ahead of important leadership changes at the 19th Communist Party of China National Congress in the fall. In turn, the government is likely to use further fiscal easing and rapid credit expansion to target growth of around 6.5%. As a result, we expect official GDP to expand by 6.0-6.75% in 2017, although actual GDP growth will likely be lower (see Exhibit 45}. The risks to our outlook are skewed to the downside for two reasons. First, the new direction of US trade policy remains uncertain and could have a sizable impact. For instance, a 15% tariff would mechanically reduce China’s GDP by 0.9%. China could respond by ramping up leverage, letting its currency depreciate faster and injecting more fiscal stimulus, but that could risk further imbalances in the economy while also disrupting global financial markets. Second, striking the right balance between stimulative and contractionary measures is a hazardous endeavor. On the road, as in government policy, accelerating and braking at the same time greatly increases the risk of an accident. India India’s streak of strong growth continues. The economy expanded by an estimated 6.5% in 2016, making it the fourth consecutive year of GDP growth in excess of 6.0%, a rare feat that India’s economy shares only with China’s. Growth would likely have been even higher, were it not for the “demonetization” scheme the government introduced in November 2016. In a surprise move, the government announced that large- denomination bank notes, representing 86% of cash in circulation, would no longer be accepted as legal tender. The scheme—intended to root out illegal income stored in cash—had the unfortunate side effect of starving households of liquidity and thereby thwarting consumption, the main engine of growth. Although the severity of the consumption shock remains uncertain, it should be temporary. The silver lining for 2017 is that India will probably benefit from a meaningful recovery in household spending. Moreover, fiscal policy will likely be eased ahead of the 15 state elections occurring in 2017 and 2018, while investment should receive a modest boost as the Reserve Bank of India lowers borrowing costs. Accordingly, we expect GDP growth of 6.5-7.5% in 2017. 46 | Goldman Sachs | JANUARY 2017 HOUSE_OVERSIGHT_014579