Yuan Drop is a Correction

CHINA - Report 26 Aug 2015 by FAN Gang and Chunyang Wang

Executive Summary

Fixed asset investment increased 10.3% y/y in real terms in July, and industrial output rose 6% y/y. Both key indicators were lower than in previous months. Although a month’s slowdown doesn’t suggest a recovery falloff, there are potential risks. The government needs to ease if it’s to encourage recovery, such as by increasing state investment, and by loosening monetary policy.

Retail sales of consumer goods rose 10.5% y/y in nominal terms in July, down 1.5 pps from June. CPI rose 1.6% y/y, up 0.4 pps from the lowest level, which was in May. The ex-factory price index of industrial products fell -5.4% y/y, and PPI fell -6.1% y/y, both record lows.

Exports fell -8.3% y/y in July, turning negative after a positive result in June, down 11.8 pps. But imports fell by a much greater -8.1% y/y.

At the end of July, M2 increased 13.3% y/y, up 1.5 pps from the end of June. M1 rose 6.6% y/y, up 2.3 pps. Total RMB loans from financial institutions rose 15.5% y/y, up 2.1 pps. However, of the increased 1.48 trillion RMB loan, 886.4 billion yuan was invested in non-bank financial institutions, a much larger increase, indicating government was implicitly bailing out the stock market. Because of the bailout, total loans to the real economy were only 129.8 billion yuan, a quarter of their level in June.

On August 11th and 12th, the yuan depreciated by close to 4%. Such a precipitous drop is quite rare, historically. The yuan joined other currencies in devaluating against the dollar. This development might be related to the export decrease in July. But the scale of depreciation is still quite small, compared to the deprecations of other currencies against the dollar. So we view the current yuan drop as a correction. We expect no “collapse,” and the RMB trend is still toward appreciation in mid to long run. Chinese stocks have recently been quite volatile. That’s not new, as major volatility is a repeated event in recent Chinese economic history, too, though the impacts on the real economy have been quite limited.

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