SEB China Update, July 2017
The economy will continue its slow grind lower from 6.9% in 2016 to 6.8% (2017) and 6.5% (2018). Growth is higher than expected because manufacturing is bottoming, commodity prices are stabilizing (e.g. steel), and European and US export demand is returning. Domestic demand has been helped by consumption growing from rise in property prices and mortgage loans. Investment and construction activities have also increased from rise in property prices.
Policy direction has changed to slow the economy since the export growth provides room for a domestic slowdown. President Xi also sees the rising debt and financial market instability as hazardous to political stability. Deleveraging has not started but total debt growth has been slowing in 2017. Politics will drive economics into year-end since China has its once in a 5 year shift in top members of the Communist Party in Oct/Nov. President Xi wants economic stability so that the transition is smooth and his people can get into the top positions in the Communist Party. Therefore, the economy will slow to prevent overheating but at a mild pace. Deleveraging will not happen but credit growth will slow to keep total debt stable as percent of GDP.
FX/Interest Rates/Equity: USDCNY will strengthen slightly to end 2017 at 6.70. USD strength is abating and China is keeping up with rising US interest rates by hiking its own short term money market interest rates. Also, due to euro strength and rise in other Asian currencies, CNY on a trade weighted basis is weakening. That means CNY can strengthen and still not lose export competitiveness. Interest rates should remain stable. Inflation will gradually rise but remain below PBoC’s comfort level of 3%. Low interest rates and stable growth provide a positive environment for the equity market to perform well. Risk: We are most worried about an upside surprise to global inflation. Global inflation can translate into domestic inflation and lead to higher domestic interest rates. Since China’s debt is so high (almost 250% of GDP), rising interest rate environment will be painful as borrowers need to increase interest payments and defaults risks rise. Services outperforming but manufacturing has bottomed.