China’s November economic data surprised broadly to the upside, suggesting that the government’s efforts to support the economy have not been in vain. A strong push on infrastructure investment (up 18% year on year) coupled with increased auto production, formed a strong tailwind for industrial production (+6.2% after +5.6% in October). Accelerating infrastructure and manufacturing investment also helped to offset the weakness in property construction, halting a persistent decline in aggregate fixed asset investment. The government’s stimulus was also manifested in the resilience of retail spending, thanks partly to strong auto sales on the back of tax relief. Apart from the stimulus, however, we think the underlying conditions for consumer spending remain healthy, as attested by the strong growth in online sales for the month (+33% year on year).
We think the pickup in growth momentum, albeit marginal, is likely to be extended in the coming months. Increased fiscal spending and higher loan disbursements will provide lingering support to the economy, making the government’s 7% growth target for 2015 stay within a comfortable reach. However, we think the current economic recovery is not yet built on solid grounds. The lack of improvement in producer price index (PPI) deflation, still weak corporate profit and elevated real funding costs suggest that economic challenges remain acute. Hence, we expect headline economic growth to decelerate further to +6.3% next year, as the government’s policy priorities shift more towards supply-side reform. While cyclical policies will still play a role to prevent economic hard landing and financial crisis, they are there to ensure macro stability, not to fight against the gravity of slowing growth, in our view.
The new yuan (CNY) index
Other major news over the weekend included the introduction of a new CNY exchange rate index, created by the China Foreign Exchange Trading System – a sub-institution of the People’s Bank of China (PBoC). The index contains 13 currencies, with the US dollar and euro accounting for close to 50% of the weight (see table 1).
We think that the introduction of the CNY index could mark a new direction in China’s FX management. As it moves away from a de-facto dollar peg to managing the yuan against a basket of currencies, the movement of this index, as opposed to the CNY/USD bilateral rate, could become the new benchmark for determining if and when the PBoC intervenes in the FX market. This suggests that the authorities may be prepared to tolerate greater yuan weakness vis-a-vis the dollar, so long as the overall index remains stable. The transition towards ‘basket management’ could also serve as a defence for China to refute criticisms of competitive devaluation, if large deprecation of the yuan index can be avoided.
While there is a risk of greater CNY/USD weakness than our current projection of 3~5% over 2016, we continue to think a moderate and controlled depreciation for the cross rate is the most feasible path going forward. A large depreciation is beneficial for the economy, but the authority has to weigh it against the risks of accelerating capital outflows and potential setbacks for renminbi (RMB) internationalisation. In that regard, we think that the official line of ‘no significant currency deprecation’ is both, an anchor of expectations, and operational guidance for the PBoC to maintain relative FX stability, so that the risks of financial disruption can be contained, and RMB internalisation can proceed.