Chief economist China
China’s two interest rate cuts will help to mitigate the downturn in the economy, but it is not enough to turn around the economy quickly. Both domestic demand and external demand are very weak. Inventory is at a high level. The interest rate cuts of 50 basis points (bp) help to lower financing costs for the firms on the margin, but the government needs to do more if they want to see growth to recover in the third quarter.
The most effective way to turn around the economy is to boost investment through infrastructure projects. For instance, railway investments are down by about 40% in the first five months of 2012, which contributed to the growth slowdown. Some improvement in this sector would help to boost demand for construction materials and transportation equipment.
Chinese premier Wen Jiabao acknowledged on July 10 that investment needs to play the key role to boost growth. We believe infrastructure investments will likely rise in coming months. Otherwise growth will likely face further downside risks.
Looking beyond 2012, potential growth is clearly on a downward trend, as excess labour supply in the rural area is depleted, and wages grow quickly which pushes up inflation structurally going forward. Growth outlook hinges critically on economic reforms after the political leadership transition in 2013.
If the government implements the right reforms, annual economic growth may still remain around 8% for the next several years. If they fail to push reforms through, growth may slow quickly with heightened risks of economic hard landing.
Senior economist/strategist for Asia ex-Japan
Crédit Agricole Corporate and Investment Bank
The rate cut of July 5 reflects concerns over a slowdown of growth in the second quarter of the year and was meant to help ensure a recovery in the second half.
It was facilitated by weaker price pressures: disinflation accelerated in June as consumer price index and producer price index inflation both fell sharply. The People’s Bank of China (PBoC) also announced further interest rate liberalisation, which added extra punch to the cut (best one-year lending rate was lowered by 85bp and by 170bp since the start of June).
The two recent rate reductions, and other measures (bank reserve requirement ratio (RRR) cuts, weaker renminbi, lending recovery, accelerated investment approvals and consumption incentives), make us confident that the government will beat its annual growth target. The second quarter gross domestic product (GDP) data confirms this, showing sequential acceleration, and a pick up of demand in June. We expect a rebound of growth in the second half and maintain an 8% forecast for 2012.
As a result, we believe that the rate-cutting cycle has likely ended. Future measures will likely include fiscal easing – via tax cuts and more spending – and improvements in access to credit – through RRR cuts (up to 150bp in the second half).
Growth outlook is good news for Chinese equities, as well as for the renminbi, which we expect to appreciate in the second half in offshore and onshore markets. The renminbi interest rate swaps (IRS) are still likely to fall at the short end as liquidity will improve through RRR cuts, but should recover in the fourth quarter. Longer tenors should trend higher during the second half, leading to a steepening of the curve. Government bond yields should also rise on increased spending.
Beijing is stepping up easing to hold up growth, as indicated by the PBoC’s faster than expected delivery of the second rate cut in its easing cycle.
The rate cut came in just barely one month after the first one in June and just ahead of the June economic data release, which confirmed that China’s second quarter GDP growth decelerated slightly faster than expected to a three-year low of 7.6% year-on-year, from 8.1% in the first quarter.
Despite initial signs of earlier easing measures starting to work, the downward pressure on growth still remains in the near term, considering the weaker than expected growth of June’s industrial production and imports, the slowing employment and wage growth plus the still challenging external environment. Although there is the upside surprise of June’s investment and credit growth, more easing actions are needed to sustain the improvement and reverse growth slowdown.
As inflation is falling fast, it provides sufficient room for further easing. Following the recent two rate cuts, Beijing still has plenty of policy room to step up monetary easing through a number of measures including additional 200bp RRR cuts for the rest of this year; fiscal easing through additional tax breaks and fiscal spending; and more effectively opening up more sectors to private investors. The chance for a further rate cut still remains, should inflation fall faster than expected.
Once the easing measures filters though to the real economy, we expect a modest growth recovery of 8.5% year-on-year in the coming quarters. However, a V-shaped recovery is unlikely to be repeated.
Global head of FX research
The timing of China’s rate cut, coming quite soon after the first, was more a surprise than the event itself. From here, we expect one more rate cut and three more RRR cuts.
Chinese policymakers have clearly moved into a more pro-growth mode via fiscal and monetary policy. This has been and will be decidedly more measured than was the case in 2009. As such the recovery, when it comes, should also be more gradual. Nevertheless, we do think that the Chinese economy is already stabilising and forecast third quarter real GDP growth at 8.2% year-on-year compared with the 7.6% just announced for the second quarter.
In this context, we take the view that markets are more focused on the trajectory of economic activity – and not just in China – than the absolute level. China is undergoing a number of simultaneous transitions and clearly slowed as part of this process in the first half.
However, on a data surprise basis, things seem to be stabilising, which should gradually be an increasing positive for regional and commodity currencies, which remain highly correlated with Chinese economic expectations. To be sure, markets remain volatile as underlying economic data in the US, Europe and Asia remain weak.
In addition, the European debt crisis continues to weigh heavily on sentiment. However, what you are seeing increasingly is that investors are taking note of Asian economic resilience and focusing on strong local stories.
We recommend overweight FX allocations in the Philippine peso, the Korean won and the Singapore dollar. From a funding perspective, we generally favour a 50/50 basket of euros and US dollars to try and strip out the volatility of the EUR-USD exchange rate.