Summary Editor: Tristan Zhuo Senior Economist Phone: +852 2826 6193 Email: tristanzhuo@bochk.com China s economic momentum strengthened somewhat in the month of August. Industrial production has largely stabilized, while retail sales remained fairly robust. Even exports are staging a nascent recovery. Overall, in spite of notable headwinds, the Chinese economy is managing to turn in a respectable performance. The RMB will be added to the IMF s SDR basket of currencies starting October 1 st, which will be Bank of China (Hong Kong) is a leading commercial banking group in Hong Kong by assets & customer deposits. BOCHK and its subsidiaries offer a comprehensive range of financial products and services to individual and corporate customers. BOCHK is one of the three note-issuing banks as well as the sole RMB clearing bank in Hong Kong. the most significant milestone to date in the Chinese currency s journey of internationalization. With SDR status, the RMB will officially become a reserve currency. China s red hot property market has all but ruled out any benchmark interest rate cuts in the foreseeable future. Reductions in the reserve requirements ratio, currently at 17%, have also become very unlikely. Given the froth in the real estate sector, further monetary accommodation will risk inflating a housing bubble.
Macro economy China s overall economic activity picked up in August, with most major indicators showing signs of improvement. Industrial production and retail sales accelerated, while fixed asset investment stabilized. Even the exports sector, long battered by weak international trade and tepid global growth, is staging a nascent recovery. More importantly, the so-called L-shaped growth has taken shape. The last time the Chinese economy grew at a double-digit pace was in 2010. From the first quarter of 2010 to the third quarter of 2012, quarterly growth on a year-on-year basis declined sharply from 12.2% to 7.4% within 11 quarters. In contrast, during the 16 quarters afterwards, the deceleration became a lot more moderate, with growth weakening only mildly from 7.4% to 6.7% in four years. In August, industrial production rose 6.3% compared to the same period last year, the second strongest monthly growth in 2016 so far. Looking ahead, the combination of domestic overcapacity and lukewarm global demand for industrial goods will still pressure the industrial sector. In spite of these headwinds though, industrial production so far has managed to grow relatively steadily around the 6% level. The respectable performance of manufacturing despite considerable downward pressure has been a major contributor to the stabilization of economic growth. Retail sales grew strongly in August, rising 10.2% from a year ago after adjusted for inflation. Retail sales have remained remarkably robust and apparently immune to temporary weakness elsewhere. As a result, the correction of the imbalance between investment and consumption appears to be making slow but steady progress. On a cumulative year-over-year basis, growth of fixed-asset investment stayed at 8.1% in August for a second straight month. Given that outsized investment has been a main culprit of China s economic imbalance, its deceleration is an indispensable component of rebalancing efforts. If China s private consumption-investment imbalance were to be improved, simple arithmetic would dictate that investment growth must slow down. From this perspective, the apparently relentless slowdown in investment should be acceptable or even welcomed. Nevertheless, the rapidly widening divergence between public and private investment is noteworthy for two reasons. For one, it suggests that, at least to some extent, the recent stabilization of overall economic activity has been propped up by public spending. For another, it reveals that confidence of the private sector is sagging. During the first eight months of the year, public fixed asset investment grew at an impressive 21.4%, while private investment expanded by a mere 2.1%. 2
Exports in dollars terms dropped 2.8% in August. Because monthly trade figures are notoriously volatile, six-month moving averages are a better indicator. By this metric, exports have been contracting for 13 consecutive months already. As sluggish merchandize trade has been a global theme and is not likely to improve materially any time soon, China will have to cope with weak external demand for an extended period of time. Nonetheless, Chinese exports are staging a nascent recovery, with the six-month moving average improving from -8.6% in February to -2.3% in August. In the current downturn, Chinese exporters have been outperforming most of their counterparts in other major export powerhouses. Monetary policy One-year benchmark deposit and lending rates are currently at 1.5% and 4.35%, respectively. Meanwhile, the reserve requirement ratio (RRR) is still at a fairly elevated 17%. Looking ahead, RRR cuts should be a preferred measure of monetary accommodation, as the two main policy tools are currently in vastly different positions. While benchmark interest rates have been cut to the lowest levels in decades, RRR s are still very high by historical standards. That being said, the frothiness of the real estate market in major Chinese cities has made RRR cuts in the near future very unlikely as policymakers will not risk further inflating the housing bubble. In August, new-home prices rose in 64 of the 70 cities tracked by the National Bureau of Statistics, gaining an average 1.2% from July for the biggest month-on-month increase since January, 2010. Currency rate As for China s currency, depreciation pressure against the dollar persists. However, in stark contrast to heightened volatility in the third and fourth quarters of last year, market participants have largely adapted to the current exchange rate regime. Moreover, the once substantial gap between onshore and offshore rates has narrowed substantially. As of September 27 th, onshore RMB depreciated 2.6% year to date against the dollar, while offshore RMB was down 1.7%. On October 1 st, the RMB will join the IMF s SDR basket of currencies, which is the most significant milestone in the RMB s journey of internationalization so far. With a weight of 10.92%, the RMB s share in the currency basket will be bigger than that of sterling and the Yen. As the RMB officially becomes a reserve currency, demand for RMB-denominated assets will likely grow over time. 3
Equities China s equity market has become a lot less volatile in recent months, yet downward pressure has yet to recede. Accommodative monetary conditions may support valuations on the margin but probably will not provide stock prices with a significant boost for two reasons. For one, interest rate cuts have been all but ruled out. For another, as funds outstanding for foreign exchange keeps dwindling, the purpose of any prospective RRR cuts will be to help maintain financial conditions instead of to inject much extra liquidity. As of September 27 th, the Shanghai Composite was down 15.3% year to date. The Shenzhen HK Connect will likely be launched by the end of the year. There will be a daily limit on net buying, but there will not be any aggregate quota. Meanwhile, the aggregate limit on the Shanghai HK Connect has been abolished. The Shenzhen HK Connect marks another major milestone in the internationalization of the RMB and China s capital account opening. Nevertheless, easier access to Hong Kong and mainland markets, for domestic and international investors, respectively, will not necessarily result in rising equities. At the time of the debut of the Shenzhen HK Connect, its Shanghai counterpart will have been in operation for about two years. Yet the Shanghai Composite and the Shenzhen Component indices have almost been moving in lockstep ever since 2009. That said, the small and medium enterprises listed in Shenzhen have far outperformed the major indices. The Shenzhen bourse is home to many of China s so-called new economy stocks, which should attract plenty of interest from international investors. Offshore RMB In July, the sum of offshore RMB deposits in Hong Kong was down by 6.2% from June. At 667.1 billion Yuan, total RMB deposits in July decreased 32.9% in 12 months and were a far cry from over 1 trillion Yuan in December, 2014. A shrinking capital pool could hinder the growth of the offshore market. In Hong Kong, there is no denying that the popularity of the RMB still largely hinges upon the currency s value against the dollar. The RMB s depreciation against the Hong Kong dollar has clearly dampened investors enthusiasm in holding RMB deposits. Unless investor sentiment of the currency s exchange rate improves markedly, a meaningful rebound of the capital pool will remain elusive. 4
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