China: Surprise rate cut as economy slows further in Q3-23

July activity indicators showed that the Chinese economy decelerated further in the first month of Q3-23 (Chart 1). The data miss came on the back of weaker credit, trade and inflation numbers last week. There are various reasons for this. Firstly, typhoon Doksuri wreaked havoc in North China, leading to torrential rains, flooding and several landslides. This disrupted consumption and investment activity, resulting in data prints that were lower than the cyclical trend. Moreover, concerns surrounding Country Garden have compounded to the persistent weakness surrounding subdued domestic sentiment, prompting households to further deleverage balance sheets.?

Industrial Production (IP) declined to 3.7% y/y, down from 4.3% y/y in June. In sequential terms, IP slowed to 0.0% m/m, down from 0.7% m/m in June. Private enterprises (2.5% y/y) continue to lag State-Owned Enterprises (SOEs, 3.4% y/y), a theme that has prevailed throughout H1-23. Automobile manufacturing remains supportive, but slowed to 6.8% y/y, down from 8.8% y/y in June. IP should stabilise in H2-23, thanks to policy support in H2-23.?

Retail sales declined more than expected to 2.5% y/y, down from 3.0% y/y in June. In sequential terms, retail sales slowed to -0.1% m/m, down from 0.2% m/m in June. The divergence across sectors was noteworthy. Catering services are still supportive (15.8% y/y), while office appliances (-13.1% y/y) and building materials (-11.2% y/y) dragged. Automobiles are a large item in the consumer basket, but sales have been slowing (-1.5% y/y) from a very high base due to negative base effects. We expect retail sales to remain broadly flat in H2-23.

Urban Fixed Asset Investment (FAI) declined to 3.4% YTD y/y, down from 3.8% YTD y /y in June. In sequential terms, FAI declines -0.02% m/m, in line with June. Private investment (-0.5% YTD y/y) was notoriously weaker than SOE investment (7.6% YTD y/y) (Chart 2). Although FAI is expected to stabilise and recover slightly in H2-23, the private sector will likely continue to lag SOEs. Most of the downside can be traced back to weaker real estate performance. Property investment declined to -8.5% YTD y/y, down from -7.9% YTD y/y in June (Chart 3). With that being said, private FAI in sectors of strategic interest continues to be remarkable, with automobiles (19.20% YTD y/y)?and electrical machinery (39.1% YTD y/y) remaining very supportive.?

The surveyed jobless rate increased to 5.3%, up from 5.2% in June. However, the NBS did not publish youth unemployment (16-24) statistics, citing the need to iron out discrepancies with complex data. The decision to stop publishing youth unemployment data will not help with international investor sentiment, as it entails a deterioration in visibility. A lot of fresh graduates would have joined the labour force in July, exerting risks on the youth unemployment front. We had expected youth unemployment to come in at 22% in July, but it looks like the actual number may have even exceeded this forecast. We estimate that China may have roughly 35 million unemployed youths. That ought to shed light on what the next policy steps might be.??

The July Politburo stressed very clearly that China would ramp up counter-cyclical support measures. We saw the first sign of that on August 15, after the People’s Bank of China (PBOC) unexpectedly cut the 1Y Medium-Term Lending Facility (MLF) rate by 15 bp to 2.50% and the 7D Reverse Repo Rate by 10 bp to 1.80% (Chart 4). According to previous modus operandi of the PBOC, we should expect a symmetrical, outsized 10-15 bp cut to the 1Y and 5Y Loan Prime Rate (LPR) on August 21. Looking forwards, we expect that the PBOC will also follow through with additional 50-75 bp in RRR cuts and balance sheet expansion to mitigate risks in key sectors, such as LGFV debt and regional housing markets.

In sum, economic activity indicators have weakened further across sectors in July. That means the sequential deceleration has extended into Q3-23, requiring concerted efforts and a faster reaction function. Although some indicators have started to inflect, August will be another weak month. That will exert pressure on Q3-23 GDP forecasts. We believe that the 5.0% growth floor for 2023 remains within reach, but the onus will now shift to 2024, as the authorities need to ensure that the economy can grow within a reasonable range. Policymakers should not lose sight of the common prosperity target of becoming a “medium-developed” country by 2035. All hands on deck.?