Lower But Stabilizing Growth

CHINA - Forecast 09 Feb 2016 by FAN Gang and Chunyang Wang

Viewed in terms of quarterly data, the weakening growth trend is dissipating. True, real GDP was up just 6.9% in 2015, down 0.5 pps from 2014, and its lowest growth rate for 25 years. But GDP in Q4 was up 6.8% y/y, down only 0.2 pps from Q1, while H2 growth was stable. And the slowdown only began diminishing after the government took major macroeconomic adjustment steps. Since July, fiscal spending has been climbing by more than 20%, and M1 has also grown fast. Fiscal spending for the year rose 15.8%, almost double the rate of 2014. We expect fiscal and monetary policy to loosen in 2016, and growth to stabilize, as it moves to the so-called “new normal.”

Industrial output was up 6.1% y/y in 2015, down 2.2 pps from 2014. But industrial output performed better in H2 than in H1, showing a sound trend within the year. Fixed asset investment rose 10% y/y in 2015, down 5.7 pps from 2014. But various indicators in Q4, such as new project openings, suggest investment will pick up in early 2016.

M1 and other key financial indicators show a loosening monetary policy with a continuous interest rate cuts in 2015. In the end of June, M1 rose only 4.3% y/y, still at a very low level. After July, M1 quickly rebounded and in the end of year, M1 growth rate rose to 15.7% y/y.

The IMF decided to add the yuan to the SDR basket in November. We expect more yuan internationalization consistent with Xi’s “one belt one road” plan. Joining the SDR also signals more financial reforms to come, which will generate steadier economic growth. The inclusion of the yuan in the SDR may help the yuan stabilize, though the differential between onshore and offshore currency valuations has persisted recently.

Pollution in China has attracted much international attention. On December 19th, the notoriously polluted city of Beijing once again issued a level-four red alert, the most serious level in the four-tier warning system. China’s pollution is a consequence of its rapid industrialization. The “new normal” – a relatively slower growth rate for structural change -- is partly a response to the problem of heavy pollution. Pollution is also pushing structural change, as industry must upgrade with environment-friendly products, by adopting successful BYD electric cars, for example.

The Central Bank on January 17th announced that it would raise the reserve requirement ratio for yuan deposits in offshore yuan-clearing banks, to stave off currency speculation. Meanwhile, China’s foreign reserves shrank by a half trillion in 2015, to $3.33 trillion. We expect the Chinese government to use such capital controls, and its still-gigantic foreign reserves, to stabilize the yuan, and to weaken it against the dollar, until the full correction (from overvaluation) is complete. Capital controls are periodically necessary, to allow China to stabilize its markets, given the country’s immature financial market, and the newness of its entry into the liberalized international capital markets.

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