Summary Editor: Tristan Zhuo Senior Economist Phone: +852 2826 6193 Email: tristanzhuo@bochk.com China s macro economy stabilized in May, and growth in the second quarter appears to be similar with the first. However, with a deteriorating global outlook, growth headwinds may become noticeably stronger in the second half of the year. The RMB s weakness against the dollar persisted in June. However, the currency has been remarkably steady in the aftermath of Brexit compared with almost all major currencies. The 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. RMB s depreciation against the dollar was relatively moderate, and the implied volatility of the currency has indeed been the lowest among all currencies. As inflation appears to have bottomed, benchmark interest rates are likely to remain unchanged for the remainder of the year. In contrast, the current level of the reserve requirement ratio remains historically high. Future monetary easing measures may take the form of a couple of RRR cuts in the second half of the year.
Macro economy Growth momentum of the Chinese economy stabilized in May but may have to face increasingly strong headwinds in the second half of the year due to the worsening outlook of the global economy. As both internal and external demand remains sluggish, the path of the Chinese economy is still likely to gradually trend downwards. China continues to shift away from its erstwhile export and investment-led model, yet consumption is becoming increasingly susceptible to the downturn in manufacturing. On a cumulative year-over-year basis, growth of fixed-asset investment slowed to 9.6% in May from 10.5% in April. This rather notable deceleration is surprising because investment had seemed to bottom around the 10% level. 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. That said, the persistent decline in investment growth will inevitably pressure GDP growth in the short term. Industrial production growth remained unchanged at 6.0% in May. Industrial production used to be most closely correlated with overall economic activity. With the share of the manufacturing sector gradually declining though, it is now less indicative of the health of the overall economy. Looking ahead, severe overcapacity will continue to be a drag on this sector. Domestic overcapacity and lukewarm global demand for industrial goods does not bode well for the prospects of the industrial sector. Growth of nominal retail sales for May slowed by 0.1 percentage points to 10.0%. As a result of favorable inflation adjustment, real growth actually strengthened to 9.7%. In spite of the uptick, retail sales adjusted for inflation have been growing less than 10% for five consecutive months. Given the sustained sluggishness in exports and manufacturing, consumption simply cannot remain immune to weakness elsewhere. While household income and retail sales are still growing faster than the overall economy, the pace of expansion would eventually slow due to weakening momentum in other sectors. Exports in dollars terms dropped 4.1% in May and has declined in 14 out of the past 17 months. Because monthly trade figures are notoriously volatile, six-month moving averages are a better indicator. By this metric, exports have been contracting for 10 consecutive months already. As sluggish merchandize trade has been a global theme and is not likely to improve any time soon, China will have to cope with weak external demand for the foreseeable future. 2
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 for a couple of reasons. For one, the origin of elevated RRR levels had to do with appreciation pressure on the RMB. In order to limit RMB appreciation, the central bank resorted to buying dollars with newly-minted RMB. The excess money supply then had to be sterilized by stringent reserve requirements. Now that two-way fluctuation of the Chinese currency has begun in earnest and the central bank s foreign exchange position continues to decline, RRR should have ample room to fall. For another, 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. Currency rate As for China s currency, depreciation pressure against the dollar persists, but recent weakness has not led to a market panic. In this sense, in contrast to heightened volatility in the third and fourth quarters of last year, currency movements in the RMB have become noticeably more orderly in spite of depreciation pressure. Although slowing growth, accommodative monetary policy, and sluggish exports continue to point to a weaker currency, market participants have largely adapted to the current exchange rate regime. In the aftermath of Brexit, the RMB showed remarkable stability. Its decline against the dollar was the smallest among major currencies except for the Yen, which rose strongly. Moreover, the RMB was the least volatile among its counterparts. As of June 28 th, the RMB declined 2.4% against the dollar year to date. Equities China s equity market has become a lot less volatile in recent months, yet downward pressure persists. 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 prospective RRR cuts will be to help maintain financial conditions instead of to inject much extra liquidity. Therefore, monetary easing measures may be largely reactionary as opposed to proactive. The outlook for equities is thus negative due to a combination of slowing growth and the reactionary nature of liquidity support. As of June 28 th, the Shanghai composite was down 17.7% year to date. 3
Offshore RMB The sum of offshore RMB deposits in Hong Kong dropped by 36.45 billion Yuan in April. At 722.98 billion Yuan, total RMB deposits in March was down 24.3% compared with the same period a year ago and a far cry from over 1 trillion Yuan in December, 2014. A shrinking capital pool could hinder the growth of the offshore market. As was mentioned above, during periods of major financial shocks, the RMB has been admirably steady compared to heightened volatility of most major currencies. Nevertheless, 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 seemingly sustained 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 rebound of the capital pool will remain elusive. 4
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