Summary Editor: Tristan Zhuo Senior Economist Phone: +852 2826 6193 Email: tristanzhuo@bochk.com In spite of fixed asset investment, industrial production, and exports all missing their targets, China s GDP growth of 6.9% for 2015 managed to come in close to the 7% goal thanks to a booming services sector and consumption. The outperformance of retail sales and services suggests that economic restructuring is on track. Chinese equities remained mired in a bear market, with the Shanghai composite losing nearly 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. 50% in eight months. While it s true that most indices worldwide are in turmoil, the extreme volatility of Chinese stocks reflects fragile investor confidence. The People s Bank of China has thus far refrained from further easing monetary policy in 2016, which probably helped stabilize the currency s exchange rate against the dollar. That being said, as two-way fluctuation has begun in earnest, the prospect of increasingly accommodative monetary policy may continue to pressure the RMB.
Macro economy In spite of recording the slowest pace of growth in 25 years, China s 6.9% expansion for 2015 met the around 7% target. While fixed asset investment, industrial production, and exports all conspired to pressure growth, the booming services sector and consumption managed to mitigate the slowdown. Services now account for 50.5% of overall economic activity and grew 8.3% in 2015. Now that interest rate liberalization is largely complete, the efficiency of capital allocation should continue to improve. In this environment, growth may trend downwards but should be more healthy and sustainable as a result of economic restructuring. Fixed-asset investment grew 10% in 2015, much lower than the 15% target. 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. However, the rather rapid pace of decline is bound to subtract from growth in the short term. Industrial production grew 6.1% in 2015, a far cry from the 8% goal set out for the year. So long as severe overcapacity remains a dark cloud hanging over the manufacturing sector, industrial production will be very unlikely to stage a strong rebound. Industrial production used to be the indicator most closely correlated with overall economic activity. However, with the share of the manufacturing sector gradually declining, industrial production, while still a very important metric, is becoming increasingly less indicative of the health of the whole economy. International trade was also rather disappointing, contracting by 7% in 2015 whereas the full-year target was 6% growth. Exports declined by 1.8%, while imports plunged 13.2%. 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. As fixed asset investment, industrial production, and exports all missing their targets, services and consumption managed to pick up the slack. The so-called tertiary sector now accounts for 50.5% of the economy, 10 percentage points larger than manufacturing. In 2015, services grew 8.3%, compared with agriculture at 3.9% and manufacturing at 6.0%. Meanwhile, retail sales remained robust and expanded by 10.7% in 2015 in nominal terms, as disposable income consistently outperformed GDP in recent years. Relatively strong retail sales and income growth give credence to the narrative that the quality of growth is improving. 2
Monetary policy After a series of easing measures, one-year benchmark deposit and lending rates have been cut to 1.5% and 4.35%, respectively. Meanwhile, the reserve requirement ratio (RRR) has been reduced to 17.5%. More importantly, the cap on deposit rates have been lifted, thus interest rate liberalization is largely completed. Market-driven interest rates should continue to improve the efficiency of capital allocation and lead to sustainable growth. 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 the exchange rate of the Chinese currency is no longer a one-way bet and the central bank s foreign exchange position has declined considerably, RRR should have ample room to fall. For another, the two main policy tools are currently at 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 The revamp of the reference rate setting mechanism in August has led to genuine two-way fluctuation. However, an unintended consequence of this adjustment is that a persistent gap has emerged between onshore and offshore rates. While the offshore CNH has recovered somewhat from its recent trough against the dollar, it remained stubbornly weaker than the onshore CNY rate. The CNH-CNY spread has become a thorny issue that needs to be addressed in order to mitigate confusion on the part of international investors. While slowing growth, increasingly accommodative monetary policy, and sluggish exports all point to a weaker currency, the PBOC has made it clear that the central bank is not pursuing a strategy of devaluation. Indeed, against a basket of major currencies and adjusted for inflation, the RMB s real effective exchange rate compiled by the BIS strengthened 3.9% in 2015, easily outperforming most counterparts. As of January 27 th, the RMB depreciated 1.3% against the dollar year to date. Equities Undeterred by growth headwinds, investors had flocked to the stock markets en masse before the rout in the second quarter. Unfortunately, as the euphoria evaporated, stocks suffered a brutal decline, with the Shanghai composite tumbling nearly 50% in eight months. While there are a number of plausible 3
explanations for the meteoric rise and the subsequent plunge in stocks, few variables may have played a more prominent role than margin financing. The outstanding balance of margin trading has been moving in lockstep with the index. In other words, stock market gyrations have been driven by leveraged bets. Such positions magnified gains on the way up but inevitably led to cascading losses on the way down. As confidence remains fragile, Chinese indices will be hard pressed to reclaim their previous highs any time soon. Moreover, easing monetary conditions may not be able to boost equities significantly for two reasons. For one, benchmark interest rates may not be reduced much further. For another, as funds outstanding for foreign exchange keeps dwindling, prospective RRR cuts should help replenish liquidity but probably will not inject much extra liquidity. As of January 28 th, the Shanghai composite was down 25% year to date. Offshore RMB Offshore RMB deposits in Hong Kong rose to 864.2 billion yuan in November for a month-over-month increase of 1.2% but were down 11.3% compared with the same period a year ago. After breaching the 1 trillion Yuan mark in December of 2014, RMB deposits may have reached a plateau. The currency s sustained depreciation against the Hong Kong dollar will inevitably dampen investors enthusiasm in holding RMB deposits. Meanwhile, the spread between CNH and CNY widened after a brief convergence, and the persistent differential between onshore and offshore rates suggests that international investors remain bearish on the outlook of the RMB against the dollar. Looking ahead, should RMB weakness lead to entrenched investor expectation of sustained depreciation, Hong Kong s offshore RMB pool could shrink further in the short term. 4
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