China Watch
Group Economics Emerging Markets Research
17 December 2015
Year ends with better data, weaker yuan China’s economy ends 2015 on a more positive note
Arjen van Dijkhuizen
Merchandise imports show early signs of a bottoming-out
Senior Economist Tel: +31 20 628 8052 arjen.van.dijkhuizen@nl.abnamro.com
Weak exports followed by CNY regime change, more CNY weakness ahead ‘A fistful of dollars in FX reserves’ to keep depreciation pace in check
Gradual slowdown is base case; transition comes with occasional hiccups
Chinese economy ends 2015 on a more positive note While consumption remained robust in recent months, despite the sharp stock market correction in June/July, the latest data suggest that industry shows signs of stabilisation as previous stimulus measures are feeding into the economy. China’s activity data for November published in the past weeks have surprised on the upside. Industrial production growth accelerated to 6.2% yoy (Oct 5.6%), retail sales accelerated for the fourth month in a row (to 11.2% yoy) and fixed asset investment remained flat at 10.2% yoy. Earlier this month, data for imports, inflation, car production and car sales and lending data also pointed in that direction, although exports continue to disappoint. Bloomberg’s alternative GDP estimate jumped to 6.85% yoy in November (October: 6.57%), not far anymore from the official growth target (and our forecast) of 7.0% for 2015.
Bloomberg GDP estimate now close to official forecast
November activity data surprise on the upside % yoy (ytd)
% yoy
13
30 25
11
20 9
15
7
10 5 11
12
13
Industrial production Source: Thomson Reuters Datastream
14 Fixed investment
15
16
Retail sales
5 08
09
10
11
Real GDP growth (official)
12
13
14
15
Bloomberg GDP estimate
Source: Bloomberg
Will China’s imports bottom out in 2016? Although China’s economy undergoes a soft landing, what the rest of the world has experienced this year is quite a “hard landing” in terms of merchandise imports. These have contracted by on average 15% yoy so far this year. This is to a large extent caused by lower import prices, reflecting China’s large import demand for commodities and the
Insights.abnamro.nl/en
16
2
China Watch - Year ends with better data, weaker yuan - 17 December 2015
sharp drop in commodity prices. Still, our calculations suggests that merchandise import volumes have contracted by more than 5% this year, which is remarkable for a country that is growing by around 7%. All this reflects China’s transition from industry to services, policies aimed at replacing imports by domestic production, and general weakness of global manufacturing and trade as China’s imports are partly related to (re-)exports. Encouragingly, there are early signs that imports are bottoming out. The sharp decline in merchandise imports in the first two months of 2015, on the back of a drop in investment, is still affecting the year-on-year numbers. Still, while merchandise imports contracted by 8.7% yoy in November (marking the 13th consecutive month of negative annual import growth), this was less than in previous months and than the 2015 average. Looking forward, we expect China’s (annual) trade data to improve next year, as we expect China’s slowdown to remain gradual and negative base effects to fade out.
Still, ‘a fistful of dollars’ in FX reserves…
Exports weak; imports bottoming out? % yoy
USD tn
60
100
45
75
30
50
15
25
0
0
CNY per USD, reversed scale
4
6
3 7 2 8 1
-15
-25
-30
-50
08
09
10
11
12
Export growth (lhs)
13
14
15
16
0
9 00
04
06
08
FX reserves (lhs)
Import growth (rhs)
Source: Thomson Reuters Datastream
02
10
12
14
USD-CNY (rhs)
Source: Thomson Reuters Datastream
China’s exports remain weak, confirming subdued global trade …, Meanwhile, at -6.8% yoy, merchandise exports remained in negative territory for the fifth consecutive month in November (-0.7% on average in 2015 so far), although they were up +2.5% mom. In terms of export destination, the weakness was quite broad based. Exports to Brazil (-46% yoy) and Russia (-40%) are plunging, but the picture is not good for the EU (-9%) and the US (-5.3%) either. These data illustrate the sluggishness of global trade, with weakness concentrated in the more trade-intensive manufacturing sectors as well as falling export prices.
… while the expensive yuan triggers changes in the CNY regime Moreover, China’s weak exports also reflect the real effective appreciation of the yuan. In real effective terms, the yuan has appreciated by 28% since 2010 and by 8% since 2013. From that perspective, changing the peg and devaluating the yuan to the strong US dollar by around 3% in August made sense. In addition, on 11 December, the China Foreign Exchange Trade System (CFETS) – a sub-institution of the People’s Bank of China (PBoC) – published a new currency index, which should better capture external competitiveness. While it remains to be seen how this index will be used, these and other recent developments could well signal a shift in China’s exchange rate policy from a de facto crawling peg versus the US dollar to a system in which the CNY is managed more broadly against a currency basket.
16
3
China Watch - Year ends with better data, weaker yuan - 17 December 2015
This make sense, as a strict peg to the US dollar does not really look optimal for several reasons. First, if China liberalises its capital account further, it will be faced with the socalled ‘impossible trinity’. This ‘Trilemma’ stipulates that a country cannot have a fixed exchange rate peg, monetary policy independence and a fully open capital account at the same time. Hence, if China wants to have room for discretionary rate cuts (we have priced in two for 2016) while the Fed is expected to hike rates further (we expect three more hikes in 2016), a CNY peg to the US dollar would come under pressure. Second, a USD peg hurts Chinese exports in times when the US dollar is exceptionally strong, as has been the case this year. Third, with the CNY now included in the SDR basket, it does not make sense for the yuan to be exclusively tied to just one other component of the basket.
We expect more CNY weakness versus the US dollar Since October, the CNY has depreciated by around 2% versus the US dollar, with the pace of depreciation becoming even sharper after formal SDR inclusion. With the CNY now included in the SDR basket, we expect the authorities to expand the scope for market forces in managing the exchange rate. We anticipate them to allow a further weakening of the currency versus the US dollar, also to support exports and re-inflate the economy. The yuan should also come under pressure due to monetary policy divergence between China and the US. Still, we do not expect the authorities to allow a massive depreciation, as that could trigger an acceleration of capital outflows. Although China has been faced with substantial capital outflows this year and FX reserves have fallen by 14% since the peak in June 2014, these remain very large by EM standards, also in terms of coverage of imports and/or external debt. This should support the yuan to a certain extent (for more information, see our FX Watch, CNY index implies weaker CNY?, published on 15 December).
In conclusion: gradual slowdown is still base case, but risks remain We expect China’s gradual slowdown to continue in 2016 and 2017, with growth falling from 7.3% in 2014 to 7% in 2015 to 6.5% in 2016 and 6% in 2017. This assumes the authorities to remain committed to add stimulus to prevent a hard landing, while consumption and services are holding up better than industry and investment. After contracting in 2015, we expect imports to bottom out next year. While China hard landing fears have clearly eased since the summer, that does not mean that risks have disappeared. China faces several macro-financial risks that, if poorly managed, have the potential to derail the economy: overcapacity in industrial and real estate sector, high overall debt levels and risks stemming from financial liberalisation, the financial sector and geopolitical issues. All in all, our baseline scenario assumes the authorities will be able to manage macro-financial risks and continue to steer China towards a soft landing. Still, China’s transition will undoubtedly come with occasional hiccups, as was clearly the case in 2015.
4
China Watch - Year ends with better data, weaker yuan - 17 December 2015
Key forecasts for the economy of China 2013
2014
2015e
2016e
2017e
GDP (% yoy)
7.7
7.3
7.0
6.5
6.0
CPI inflation (% yoy)
2.6
2.1
1.5
2.0
2.5
-1.9
-1.8
-2.5
-3.0
-3.0
Government debt (% GDP)
15
15
17
19
20
Current account (% GDP)
1.6
2.1
3.0
3.0
2.0
Gross fixed investment (% GDP)
44.6
44.0
41.5
40.9
40.4
Gross national savings (% GDP)
48.0
48.0
46.5
45.0
43.5
USD/CNY (eop)
6.1
6.2
6.4
6.6
6.5
EUR/CNY (eop)
8.4
7.5
6.7
6.2
7.2
Budget balance (% GDP)
Budget b alance, current acc. for 2015, 2016 and 2017 are rounded figures
Source: EIU, ABN AMRO Group Economics
All publications of ABN AMRO on macro-economics, commodities and sector developments can be found on: insights.abnamro.nl/en Follow Group Economics on Twitter: https://twitter.com/abnamroeconomen This document has been prepared by ABN AMRO. It is solely intended to provide financial and general information on economics. The information in this document is strictly proprietary and is being supplied to you solely for your information. It may not (in whole or in part) be reproduced, distributed or passed to a third party or used for any other purposes than stated above. This document is informative in nature and does not constitute an offer of securities to the public, nor a solicitation to make such an offer. No reliance may be placed for any purposes whatsoever on the information, opinions, forecasts and assumptions contained in the document or on its completeness, accuracy or fairness. No representation or warranty, express or implied, is given by or on behalf of ABN AMRO, or any of its directors, officers, agents, affiliates, group companies, or employees as to the accuracy or completeness of the information contained in this document and no liability is accepted for any loss, arising, directly or indirectly, from any use of such information. The views and opinions expressed herein may be subject to change at any given time and ABN AMRO is under no obligation to update the information contained in this document after the date thereof. Before investing in any product of ABN AMRO Bank N.V., you should obtain information on various financial and other risks and any possible restrictions that you and your investments activities may encounter under applicable laws and regulations. If, after reading this document, you consider investing in a product, you are advised to discuss such an investment with your relationship manager or personal advisor and check whether the relevant product –considering the risks involved- is appropriate within your investment activities. The value of your investments may fluctuate. Past performance is no guarantee for future returns. ABN AMRO reserves the right to make amendments to this material. © Copyright 2015 ABN AMRO Bank N.V. and affiliated companies ("ABN AMRO”).