Bubble Burst, the Chinese Way

CHINA - Report 29 Jul 2015 by FAN Gang and Chunyang Wang

Executive Summary

Though growth is still low, we expect it to pick up H2, driven by several positive factors. GDP grew 7% y/y in Q2, flat on Q1.

Industrial output in Q2 was up 6.3% y/y, virtually flat on Q1. But output was up 6.8% y/y in June, its highest level this year, and up 1.2 pps from its March low.

Fixed asset investment rose 6.4% y/y, down 3.1 pps from Q1. But the government is taking positive investment steps now. In June, state and state-controlled investment rose 15.9% y/y, up significantly from April and May.

Retail sales of consumer goods were up 10.2% y/y in June in nominal terms, but down 0.4 pps from May. Exports were up 2.8% y/y in dollar terms, finally turning positive. We expect exports to improve in H2, as the negative currency appreciation effect will be weaker. Imports also strengthened, though still fell -6.1% y/y.

CPI in June rose 1.4% y/y, up 0.2 pps from May. The ex-factory price index of industrial products fell -4.8% y/y, and PPI fell -5.6% y/y. Prices are expected to improve in H2.

Overly tight monetary policy has continued to loosen. Adjusted M1 rose 6% y/y, and adjusted RMB savings by non-financial enterprises rose 6.9% y/y, both more than in May. Moreover, on June 24th, the State Council, led by Prime Minister Keqiang Li, announced it was scrapping a rule that caps lending by commercial banks at 75% of their deposits. This policy change will boost credit expansion, as China tries to revive economic growth.

The Shanghai stock market plunged 30% in the three weeks to July 9th, and more than half of listed companies filed for a trading halt. Subsequent government intervention is slowly helping the stock market rebound. But the moral hazard problem created by such action might create an even bigger bubble in the future.
The real estate market quickly recovered in Q2: property sales volumes shifted from falling -9.2% y/y in Q1 to rising 13.2% y/y. The value of sales shifted from falling -9.3% y/y in Q1 to rising 24.3% y/y. And the two indices rose 15.9% and 31.9% y/y, respectively, in June. The recovery is due to the stock market volatility, which is driving risk-averse investors to shift money into real estate. Stock market performance is now more related to protection of investor rights, which China cannot improve in the short term, while the real estate market is more closely linked to the real economy. China’s ability to smooth its economic cycles, due to the central government’s strong budgetary situation, means real estate investors face less risk.

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