Macro Monday:SDR or exports, that is the question

Major macro themes of the past week.

Market sentiment remains weak: Last week A-shares rose 2% afterslumping 10% in the previous week. H-shares also stabilized, closing theweek up 0.9%. However, investors remained very cautious, as A-shareaverage daily turnover dropped to RMB846bn last week, the first week of sub-RMB1tn since mid-March. HK daily turnover dropped to HK$72bn.

Discussions with clients suggest that sentiment is very weak at this stage. Weare more constructive. We expect the economy to move sideways in 3Q thenrebound visibly in 4Q, driven by government and property investment (see our20-page macro outlook for 2H: A U-shaped recovery).

Fiscal stimulus to be ramped up: We expect monetary easing to continue in2H, but not as intensive as 1H. Specifically, we expect one interest rate cut(25bp) and two RRR cuts (100bp) in 2H, vs. three interest rate cuts (75bp)and two RRR cuts (150bp) in 1H. Meanwhile, fiscal easing would be rampedup, supported by policy bank lending. The impact from fiscal policy will bevisible from Sep when the weather cools down. One could watch out forcement price and PMI (Fig 14 & 24) for green shoots. That said, big easingreminiscent of another “4tn stimulus” is unlikely. Policy makers will be happyjust keeping infrastructure FAI growth at around 20% in 2H15 (Fig 21).

Weak export data in July due to high base and strong RMB: Exportgrowth plunged to -8.3% yoy in July from 2.8% in June. Meanwhile, importdata (-8.1%) was largely in line. The disappointing export data should bepartly attributed to the high base and partly to the strong RMB. In the past 12months, the RMB has appreciated by 23% and 17% against the Euro and theYen, respectively. As a result, so far this year, China’s exports to the EU andJapan have declined by 4% and 11% yoy, while those to the US have risen by7%. In 2H, we expect some modest weakening of the RMB against the US$,but no big depreciation for two reasons. First, China had a trade surplus ofUS$306bn in Jan-Jul 2015, vs. US$150bn in the same period last year. Giventhe upcoming SDR review this Nov, it’s hard for the RMB to depreciate with adoubled trade surplus. Second, a weakening RMB would lead to capitaloutflows from China.

SDR decision and eased capital outflows: Last week, the IMF proposed topostpone the change in the SDR basket for 9 months to Sep 2016. Accordingto the explanation from the IMF later, the SDR decision will still be made bythe year-end. In our view, the odds for China to be included are pretty high,while other super powers will grab this opportunity to push China for morefinancial opening. Last week, the PBoC also released 2Q BoP data, showingChina’s FX reserves increased by US$13bn in 2Q15 after a US$80bn declinein 1Q, suggesting eased capital outflows thanks to a stable RMB.

CPI lifted by pork, PPI dipped further: July inflation data released over theweekend showed CPI edged up to 1.6% yoy from 1.4% in Jun, largely drivenby higher pork prices, which jumped 17% yoy in Jul vs. 7% in Jun. That said,we do not see pork price as a serious threat to inflation or monetary policy. Inthe 2Q monetary policy report released last Friday, the PBoC made it veryclear that monetary policy will be set by overall price trend rather than byindividual goods prices. Meanwhile, PPI in July surprised to the downside,falling 5.4% yoy (Jun: -4.8%). The decline was concentrated in mining andraw materials sectors, mainly driven by the renewed weakness in commodityprices since Jun (Fig 22- 26).