China roundup: the doomsayers are getting louder

It has been a big month of data releases from China, most of which haven’t painted a very rosy picture of the economy. The biggest release was Q4 GDP numbers which showed that the economy grew 7.4% YTD y/y, missing the government’s official 7.5% growth target for last year. It’s true that this was a soft and outdated target, thus it didn’t come as a surprise to the market when the economy grew at a slower pace, but the possibility of an even harsher slowdown this year is at the forefront of investor sentiment.

There are two main sources of growth in a modern economy: domestic demand and global demand. China has historically been an export based economy, but it is attempting to transition towards a more effective growth model that takes advantage of China’s massive population. As urbanisation continues to transform China into a more developed economy, it can tap into a more reliable and sustainable growth conduits stemming from within its own economy.

However, domestic demand remains depressed in China. Consumer price growth remains trapped around 1.5% y/y and persistent deflation in producer prices due to massive overcapacity is becoming a real concern. This is further emphasised by a record 8% fall in industrial profits last month. Also, a dogged lack of import growth and falling retail sales highlight the lack of consumer demand. The big thing propping up growth is China robust export market.

A lot of onlookers say that the lack of economic activity in China is routed in the slowdown of fixed investment, which is clearly represented in the property market by plummeting prices. Property sales fell 7.6% and unsold floor space increased 26.1% last year, highlighting chronic oversupply. There were some tentative signs towards the end of last year that property prices in China’s major cities may be nearing a bottom, but these signals faded in December, so the problem of an eroding property market is expected to be a major theme in 2015.

The PBoC is fighting the slowdown

Late last year the PBoC took the drastic step of cutting interest rates to help stimulate growth, before it took more action earlier this month by interjecting funds into the banking system via open-market operations for the first time in a year. Both measures are aimed at promoting economic activity in response to a sharper than expected downturn in growth. Yet, more needs to be down if the economy is to avoid an even sharper downturn, which may come in the form of more liquidity injections, a RRR cut and/or interest rate cuts.

The yuan

The need to make monetary policy more accommodative in China may keep USDCNY afloat in 2015. When the Fed begins hiking interest rates will be another major theme for the pair, especially if the Fed begins tightening sooner or later than currently expected. In China, the idea of the yuan as a one-way beat was clearly dispelled in 2014, thus the market may be more comfortable will CNY weakness than it was only a couple of years ago. Also, the PBoC may also be more comfortable with a weaker yuan, as it would provide much needed support for China’s all-important export sector. We are keeping an eye on 2014’s high just above 6.26