China: Fiscal and monetary policy easing to offset growth slowdown

China’s economic growth moderated to 6.7%YoY in Q2, 2018, mainly due to a deceleration in investment and net exports. The growth of fixed asset investment reached a historical low of 6%YoY, with local infrastructure spending being a drag. Industrial value-added also weakened especially in the old economy sectors like mining and utilities.

On the external front, after two week months, exports bounced back in June to double-digit growth, which led to an improvement in the trade balance (USD 41.6bn). The most likely reason is a frontloading of exports in the light of the import tariffs raised by the US against China in early July. For more details, please see our report. 

The only bright spot in the second quarter was domestic consumption, which contributed 5.3% of the 6.7% growth rate. However, the outlook for consumption is also increasingly uncertain as the readings of retail sales growth decelerated below 10%YoY since April.

The prospects of a much faster deceleration of the Chinese economy have weighed on asset markets, especially equity prices. In fact, stocks have lost almost 30% since the peak in January and the Shanghai composite reached the lowest level since December, 2014. The real estate market seems to be less affected especially in the first-tier cities where property prices only slowed moderately compared with the previous month. Second and third tier cities, in turn, stopped their price expansion.

Against the backdrop, the Chinese government has embarked in a fiscal and monetary stimuli, which can be considered increasingly relevant. As regards fiscal policy, the government has announced that it will further reduce corporate and individual taxes. To support such fiscal measures, in terms of a relatively lower cost of funding, the People's Bank of China (PBoC) has just used the medium-term lending facility (MLF) beyond the earlier three cuts in the Reserve Requirement Ratio (RRR). In addition, the PBoC has announced that banks will also have a laxer “structural parameter” in the Macro Prudential Assessment (MPA), implying more room for credit growth.

As a result of a laxer combo of monetary and fiscal policies, the RMB has experienced drastic depreciation from 6.40 on 12th of June to 6.81 on 27th of July, dropping to the weakest point since June 2017. While the market is concerned that the RMB may be used as a tool against the US trade measures, we argue that the depreciation is market driven as a weak currency, especially against the USD is not necessarily in China’s favor. On the one hand, it can only raise concerns regarding renewed capital outflows. On the other, it could be the trigger additional action from the US related to potential currency manipulation. In fact, offshore bond defaults have already increased in number so far, and the onshore-offshore yield differentials turned further negative for most sectors.

Going forward, we believe that the fiscal and monetary combo will support growth at levels similar to that of last year, which implies a slight upwards adjustment to our previous forecast to 6.6% YoY (from 6.5%) for 2018.

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