More Uncertainty Over the Yuan
There’s downward pressure on growth, though we also expect growth rates to stabilize. GDP grew 6.7% y/y in Q2, flat on Q1. Industrial output was up 6.1% y/y. Though growth was 0.3 pps faster than in Q1, the recovery is weak.
Retail sales of social consumption goods rose 10.2% y/y in nominal terms in Q2, down 0.1 pps from Q1. After taking out price factors, they rose 9.8% y/y, up 0.1 pps from Q1. Overall prices are rising, mainly driven by producer prices, though these are still running at negative growth rates. The ex-factory price index of industrial products in June fell -2.6% y/y, up 0.2 pps from May.
Public fiscal revenues rose 7.1% y/y in H1, and spending rose 15.1% y/y. In Q2, imports fell -6.8% y/y, up 6.7 pps from Q1. After correcting for seasonal factors, imports have been recovering since March. Import recovery is not due to stronger demand, but to firms’ substitution of overseas goods, considering the increase of domestic producer goods’ prices due to continuing supply-side reform. Exports were down -4.6% y/y and, though up 5.1 pps from Q1, still could dip again. Capital flight is vanishing, in our view, and has stabilized.
China’s tax system underwent a major shift on May 1st, when the VAT system was extended to all sectors. Previously, firms paid tax based on their revenue; they’ll now enjoy a large tax reduction. We estimate that business taxes will fall by over RMB 300 billion. But the VAT reform will also generate enormous growth opportunities, especially for mid-sized firms that are mostly private, and will generate more jobs.
By end of June, Chinese outbound M&A, at $111.6 billion, had already surpassed last year’s levels, of $111.5 billion, and that figure was likewise a leap from around $70 billion in 2014. This is another reflection of the trend toward more global integration, an emphasis of the current government. Outgoing investment includes the official ODI through the “One Belt, One Road” national strategy. A large portion of these cross-border M&A deals took place in the technology sector, which will definitely favor China’s industrial upgrading and productivity, and generate more sustained growth.
The June 23rd Brexit referendum triggered a series of financial and economic consequences, such as the weakening of the pound. Brexit would certainly disturb British trade with China, though it also creates an opportunity for China’s heated overseas enterprise expansion into the rest of the world. Pound depreciation will, on the one hand, put depreciation pressure on the yuan, given its major role in the currency basket to which the yuan pegs. On the other hand, the close relation between the United States and Europe will reduce the likelihood of the Fed hiking interest rates, due to such high counterparty uncertainty. And that will reduce the prospects for yuan depreciation.
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