China: Keep deleveraging - ING

Iris Pang, Research Analyst at ING, notes that in July, the two eye-catching points for China were strong GDP growth and CNY appreciation and both these factors support the government’s continued deleveraging process in the corporate and financial sectors.

Key Quotes

“GDP grew a higher-than-expected 6.9% YoY in 2Q17. Retail sales, fixed asset investments and industrial production data confirm our view that China is now a consumption-driven economy.”

“Consumption and exports will continue to drive growth in 2H17, and these two categories of GDP will continue to support industrial production. Investment will play a smaller role in industrial production, especially as property developments in prime locations are likely to slow down. Altogether, this should mean slower GDP growth in 2H17 but to a lesser extent than we had previously thought. We have revised up our forecast for GDP for the whole of 2017 to 6.8%.”

“The CNY has also been very strong against the USD (6.7266 on 31 July), and heading close to our end-of-year forecast of USD/CNY 6.72. CNY appreciation of 0.8% in a month is a surprise to us even though our forecast has been at the high end of market consensus. It seems to us that the PBoC is taking advantage of the weak dollar to let the CNY appreciate, and this could have done the job for the central bank to slow down capital outflows.”

“Looking forward, the central bank may wait to confirm that the stronger CNY has prevented net capital outflows. Therefore we do not expect the current appreciation speed to be sustained in August. The current strength of the currency should be enough to shift market expectation for 2H17 from CNY depreciation to appreciation, and change the course of capital flows. We therefore keep our forecast of USDCNY at 6.72 by end- 2017.”

“As well as removing concerns over capital outflows, stronger growth and a stronger currency enable the government to worry less about the negative impacts from further deleveraging. We expect regulators to focus more on deleveraging in August. The 5th Financial Working Conference set a reform agenda for the coming 5 years, and highlighted the creation of a supervision entity, which is directly under the State Council. This signals how the government values the importance of coordinated work across regulators during the deleveraging process.”

“Seeing that there is more room for deleveraging, we expect the PBoC will either maintain the current tightness in the interbank market or even tighten slightly further in 3Q17. For the same reason, interest rates should edge higher after softening in July. We believe the PBoC will guide short-end rates gradually higher to make it clear to the market that they are not ready to ease liquidity and regulatory measures. To do otherwise, would send a contradictory message when the central government focus is on deleveraging.”