Less Pessimistic than Others
Executive Summary
People’s Bank of China Governor Xiaochuan Zhou announced in March that deposit interest rates would likely be “liberalized” in a year or two. Four days later, the Bank announced on its website that the daily trading band for the RMB would broaden to 2% from 1%, starting on March 17th.
The yuan has been depreciating against the dollar since January 14th, and hit a seven-month nadir of 6.225 on April 21st. The currency depreciated about 3% over that period. This is naturally linked to domestic slowdown, but also seems to correct for overvaluation driven by massive hot money inflows.
GDP expanded 7.4% y/y in Q1, its lowest rate for six quarters. Value added for all state and non-state industrial firms with annual turnover of more than 5 million yuan increased 8.7% y/y in Q1, down 1.3 pps from Q4 2013. Domestic demand also slowed. Retail sales of social consumption goods in Q1 rose 12% y/y in nominal terms, down 1.5 pps from Q4.
The slowdown has hit trade: exports fell -3.4% y/y in Q1, partly due to 2013’s high base number. Imports grew 1.6% y/y in Q1, down 5.6 pps from Q4. All money and credit growth indicators have decreased. M2 rose just 12.1% y/y in March. Moreover, M0 grew at its lowest rate since 1991, except for the Spring Festival period.
Financial reform was the key focus of Q1. Prime Minister Keqiang Li stated at a March 13th press conference that the government had already developed a timeline to strengthen regulation, after the State Council’s release of shadow banking regulation document No. 107. Although shadow banking has grown fast, its size relative to GDP is still much smaller than in the United States. Early awareness of potential risks, coupled with financial regulation, will mitigate financial risks. We argue that prudential regulation is necessary in order for the Chinese economy to enjoy sustained growth.
At the Bo-ao forum on April 10th and 11th, Li said China would promote a Shanghai-Hong Kong stock exchange connectivity mechanism. Other key issues heatedly debated were Internet finance and private banking. We view these financial reforms as a new source of economic growth, though prudential regulation will still be necessary. We predict that reforms should make a 7.5% of GDP growth target achievable this year – and in this we are less pessimistic than other analysts.
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