Growth Can Hit Official Targets

CHINA - Forecast 03 Aug 2014 by FAN Gang and Chunyang Wang

Executive Summary

We can see the possibility of a growth rebound, after the government raised investment, and cut the reserve requirement ratio for banks, at the end of June. Though the real economy hasn’t yet seen any impact, both public spending and the money supply immediately rose.

Economic indicators for Q2 were relatively stable. GDP was growing 7.5% y/y; retail sales of consumer goods were up 12.1%; and the GDP deflator grew 1.34%. We see this year’s targeted 7.5% growth rate as attainable. Public fiscal revenues rose 8.8% y/y in H1, and spending rose 15.8%, but we still expect to see a fiscal surplus of around 500 billion yuan for each quarter (though that’s less than in 2013). The trade surplus in Q2 was $86.2 billion, dramatically up from the $16.7 billion of Q1. Capital outflows and FDI in H1 rose a tepid 2.2% y/y to $63.33 billion, reflecting foreign investors’ fading confidence amid growth slowdown.

The yuan depreciated about 3.26% in H1. We argue that this is due to China’s economic slowdown, plus a correction for previous overvaluation, driven by massive hot money inflows. We don’t expect currency depression to last long, as we are confident that the economy is fundamentally robust. Though the economy is experiencing structural changes, the still-significant U.S.-China trade deficit will push China to strengthen its currency over time.

We expect the State Council’s May 19th decision to allow 10 provinces and cities to issue municipal bonds on a trial basis to alleviate fiscal pressures on local government, and to lower debt risk. The moral hazard problem is unlikely to be as bad as some have argued. Local government relies heavily upon selling land to raise funds, a phenomenon vociferously criticized as contributing to the housing price boom. But decreased fiscal pressure will mitigate this dynamic.

China might be following the path of Japan, which also has a high savings rate and high debt ratio, mainly financed by domestic citizens (China’s savings rate is quite high as well). This will definitely ease potential inflation pressure, as bonds will attract some money. So monetary policy does not need to be so tight, and government will have less leverage to use monetary policy as a stimulus.

Prime Minister Keqiang Li chaired a State Council executive meeting June 16th, where he stressed the need for all branches and levels of government to do sound work, and to be responsible for seeking practical results. The meeting was held in response to lower government investment, and to slower fiscal spending: some government projects are far behind schedule. Unlike other analysts, we argue that the recent fiscal expansion is not a so-called “mini stimulus,” but a response to government officials’ slow action, and an effort to lift investment demand back to normal levels.

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