UBS | Economic data points to stabilization, but manufacturing and private investment weakened further. FAI growth’s disappointing slide to 7.5%y/y was mostly dragged down by a high base, weaker property investment, and sharper weakening of manufacturing. The last was weighed down by weaker exports and domestic demand, excess capacity in many industries, and the government’s recent revival of its supply- side reform agenda which restricts investment in certain sectors. That said, firmer domestic demand enabled headline IP to grow by 6%y/y again and to strengthen sequentially despite weaker May exports. Retail sales softened in nominal terms but stayed strong in real terms, with auto- sales recovering. Although overall credit growth cooled (despite faster loan growth), we see it more as a continued normalization of credit growth (from the notable credit acceleration earlier this year) rather than a significant tightening.
Property activity moderated but remained strong. Property sales moderated as expected to a still -strong 24%y/y in May, due to a high base, the earlier concentrated release of pent -up demand, and recent modest tightening of property polices in selected cities. New starts lost steam too to grow by 10%y/y.Property investment decelerated more visibly to 6.6%y/y, underscoring the fragile improvement in developer sentiment and our view that not all new starts in recent months have been translated into active investment.
Shifting market expectations for the US Fed revived RMB volatility, as China’s FX reserves declined in May. Large shifts in market expectations about the US Fed saw RMB volatility revive and the currency depreciate by over 1.5% in May. At the same time, headline FX reserves went back into decline; falling by $28 billion to $3.19 trillion, implying non- FDI capital outflows of $28 billion last month. China’s monthly outflows have eased off notably from more than $150 billion in December and January to $30-40 billion in recent months. Despite coinciding with USD weakness, this decline and relative stabilization evidences to us that Chinese capital controls have been rather effective so far.
What to expect?
Policy on hold for now, but may intensify again once growth slows. Still firm property sales should support construction for a while longer, as the impact of earlier policy easing continues to underpin infrastructure investment. We expect growth in Q2 to be firmer than Q1 on a sequential basis, but not much improved on a y/y basis, and to lose steam later in the year. Credit policy will likely resume a more normalized pace going forwards but remain accommodative to support growth and facilitate structural reforms. We see macro policies staying on hold until Q4, when slower growth may prompt additional support again, and maintain our full year GDP growth of 6.6%.
True test for China’s capital outflow controls may have yet to arrive ; and controls may need to be tightened even more if a much stronger USD was to apply significantly greater pressures on the RMB again. Underlying capital outflow pressures may have stabilized somewhat for now, but may resume again when expectations for US Fed rate hike(s) revive. FX reserves should stay above $3 trillion for most of 2016 and end the year at >$2.8 trillion.
Despite the recent revival of RMB volatility, we still do not expect a sharp RMB depreciation. The impact from the next Fed rate hike(s) on the RMB will likely be smaller than last December, given China’s tighter controls, lower FX liabilities and clearer exchange rate policy communications. We expect USDCNY to trade around 6.7 by end 2016, and do not see it finishing the year beyond 6.8 even if USD strengthens more than our current expectations.