China 2016 GDP Review: Will Trump rock the boat?
China’s economy expanded by 6.7% for the whole year of 2016, as widely expected. The stabilization of the economy was largely due to the rally in the property market, which has also triggered concerns of asset bubble. In the coming year, China will put more effort to balance the growth, financial risks and external challenges especially from Trump. We believe that the overall growth profile will remain stable, but CNY will continue to weaken.
Property rally saved the day…
China’s economy grew 6.8% y/y in Q4 2016, one notch higher than market expectations and up from 6.7% in Q3 2016. On a seasonally adjusted basis, the economy expanded by 1.7% in the quarter, compared with 1.8% in Q3, pointing to a stabilization in growth momentum. For the whole year of 2016, China’s economy gained 6.7% y/y, within the 6.5-7.0% growth target range. (Chart 1)
In our view, the property rally has boosted the growth in the past year. The concern though is that Chinese banks have significantly increased their exposure to mortgage loans as well. In fact, the economy is still largely dependent on credit-fuelled growth model, as the overall leveraging ratio is still on the rise, albeit at a slower pace.
Activity indicators illustrate slowing momentum
China’s activity indicators illustrated a slowing momentum in December 2016. Retail sales grew 10.9% y/y in December, up from 10.8% previously. However, on a seasonally adjusted basis, retail sales slowed to 0.89 m/m in December, from 0.98% in November. Industrial production slowed to 6.0% y/y In December, down from 6.2% in November. In the meantime, fixed asset investment surprised the market on the downside, gaining 8.1% for the whole year of 2016, down from last reading of 8.3%. On a seasonally adjusted basis, industrial production and fixed asset investment moderated to 0.46% and 0.53% m/m respectively, from 0.51% and 0.57% previously.
Notably, private investment remained soft, at 3.2% for 2016. In the meantime, the investment from state-owned enterprises was pretty strong at 18.7% y/y in 2016. (Chart 2) Obviously, the increased spending in the public sectors is not sufficient to offset the drop in the private investment.
Bubble deflating and Trump’s policy…
Looking ahead, challenges remain for China’s economy. On the domestic front, China needs to find a balance between chasing growth and deflating asset bubbles. In the past few quarters, China’s property prices have grown rapidly, led by first-tier cities. As a result, the headline property price index has hit a record high in Q4 2016; however, the rental yields have dropped to record low. (Chart 3) In order to contain the asset bubbles and prevent the financial risks, China has launched a new round of property curb policies since October 2016. Indeed, the property market has shown signs of cooling with the transaction volume in the bigger cities dropping sharply in the past few months. A continual slowdown in the property market will add downward pressure to the economy, and China will have to find new growth engines to sustain its pace of growth.
Unfortunately, China can’t rely on external markets even though the US economy has illustrated signs of improving momentum. The bilateral relationship between China and the US will be tricky as Trump has threatened to label China as a currency manipulator and to levy an elevated tariff on “Made in China”. In response, during the World Economic Forum in Davos this week, China’s President Xi Jinping has clearly expressed his dissatisfaction on Trump’s protectionism.
Growth and inflation likely stable in 2017
We think that it makes sense for China to tolerate a growth moderation in the coming year, while leaving more flexibility to structural reforms. In our view, China is likely to lower the growth target to “around 6.5%” in March’s National People’s Congress. As “bubble deflating” tops the policy agenda in the coming year, China could revise the M2 growth target down to 12% in 2017 from 13% in 2016. Balancing all these factors, we forecast that China’s economy will grow 6.5% in 2017, and the CPI inflation will remain manageable, at around 2.2% in 2017 versus 2.0% in 2016.
…but CNY will continue to weaken
CNY exchange rate remains as the key topic. There is no doubt that the path of USD-CNY will be volatile: On one hand, the PBoC remains active in FX market and the Chinese authorities could further tighten capital control measures when they deem necessary. On the other hand, Trump does not want to see a strong USD which in his opinion “is killing us”.
Fundamentally speaking, CNY is still under pressure to weaken, given the growth moderation, rising risks of asset bubble and poor return of CNY-denominated assets. In the meantime, the persisting capital outflows will add pressure on CNY as well. (Chart 4) We therefore maintain our USD-CNY forecast at 7.15 by the end of this year.