Capital Outflow Fears Overstated
GDP growth and fixed asset investment both fell in Q3, and producer prices fell further, continuing their deflation cycle. GDP was up 6.9% y/y in Q3, down 0.1 pps from Q2. Industrial output was up 5.9%, down 0.4 pps. Fixed asset investment was up 6.8% y/y in September and 8.7% y/y in Q3. Quarterly growth has fallen below 10%. Retail sales of consumer goods were up 10.7% in nominal terms, up just 0.5 pps from Q2.
The trade surplus reached a record high in Q3, of $163.6 billion, because imports fell more than exports. Exports fell -5.9% y/y, and imports fell -14.4%. But we expect export growth to turn positive in November.
The CPI was up 1.6% y/y in September, and down 0.4 pps from August. The ex-factory price index of industrial products in September fell -5.9% y/y, and PPI fell -6.8% y/y, the largest decreases since the downturn -- and the two indicators have been falling for 43 and 42 months respectively.
On October 23rd, China announced its sixth interest rate cut in less than a year. The one-year lending rate will fall to 4.35% from 4.6%, while the one-year deposit rate will fall to 1.5% from 1.75%. Reserve requirements for all banks were lowered by 50 basis points, with an extra 50 bp cut for some institutions. M1 has risen quickly for the past three months, and has increased 11.4% y/y in September. From historical data, we expect the loosened monetary policy to have positive effects on the economy after six months. The monetary expansion has led banks to invest in some risky assets – and those risks cannot be neglected.
China’s FX reserves are declining fast, from their peak of $4 trillion in June 2014 to $3.5 trillion now. Though that trend has drawn much international attention, we view capital flight worries as overstated. Depreciations of the euro and yen have lowered FX reserves, and account for much of the reserve decline. The capital account is still open, in a limited way. Chinese overseas investment will eventually bring returns. And the reserve is any case often decried as excessively high.
Though capital outflows might be due to yuan depreciation expectations, we expect depreciation to be minor and short term, given China’s large trade surplus and good economic fundamentals. The government recently set up an experimental“individuals QDII program” (we may call this QDII-2) in six major cities, to allow Chinese individuals (not just institutions) to make foreign currency-denominated investments overseas. This indicates that policies are still encouraging capital outflows, and that these are still within a comfortable range.
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