Downside Risks Loom Large
Executive Summary
Chinese leaders saw this slowdown coming. Shortly before Q2 growth data were released – revealing growth at 7.5% y/y -- Premier Li Keqiang vowed to safeguard “bottom lines.” Yet we may see further slowing in Q3. Some pundits suggest the bottom line might be the 7% target noted in China’s 2011-2015 Five Year Plan. Though that was the official figure, many Chinese leaders had in fact counted on 8% growth or more. What’s Li’s true view? That’s an open question: His “bottom line” could be 7.5%, or 7%. Analysts disagree.
But no major policy initiatives seem to be in the making.Though there have been calls to deepen financial reform, support small business, cut corporate tax burdens and slice surcharges for export-oriented firms, no new initiatives for monetary or fiscal policy have been floated. Yet the space for monetary easing has actually grown. CPI inflation is still subdued, and PPI keeps deflating, while real interest rates have climbed.
The RMB appreciated prodigiously in H1 – due both to its strengthening against the dollar, and the dollar’s strengthening against other major currencies. Yet the strong RMB seems increasingly unsustainable. A Central Bank rate cut would probably fuel downward pressure on the RMB, and lead to money outflows.
Fiscal revenue keeps increasing, though more slowly than nominal GDP, due to slowdowns in industrial output and trade growth. The property market boom has been the chief pillar for revenue growth. But how long can that last? It seems Beijing won’t take seriously its so-called “proactive fiscal policy.” Trade growth rapidly slowed in H1, and even fell in dollar terms in June. We expect growth to slow further in H2. How will China manage the slowdown, and shift into recovery mode? That’s the key challenge.
The People’s Bank of China announced in late July that banks can now set their own lending rates, and the interest rate on discounting bills. Mortgage lending to individuals, though, will remain under Central Bank control. Many believe that the immediate impacts on interest rates will be small, as banks have already lowered their rates. But the commercial paper market may see acceleration. Tight regulation on deposit rates is expected to remain for the foreseeable future.
The city of Shanghai has reportedly proposed a “Shanghai Free Trade Zone.” The intent is to provide a venue for trade and currency transactions free of the typical Chinese restrictions. Though Beijing is unlikely to give a green light anytime soon, the city should be able to move forward with much of its plan on its own.
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