China Macro:Weak July data could put more pressure on RMB

The NBS just released the July economic data, which was weaker thanexpected. Industrial production (IP) growth, the most important monthlyindicator in China, slowed to 6.0% yoy in July (consensus: 6.6%) from 6.8% inJune. The slowdown was due largely to weak investment and externaldemand. As such, policy easing should continue, including ramped upinfrastructure spending as well as one RRR cut in Aug. We remain positive onan investment-led recovery in 4Q, when GDP growth could rebound to 7.2%yoy from 6.8% in 3Q (see our 2H outlook: A U-shaped recovery). That said,today’s disappointing data would raise concerns on the Chinese economy andput more pressure on the RMB in the short term.

Weak activity in July: Power generation fell 2% yoy while cement productiondeclined 5%, pointing to sluggish activity. On the one hand, this is due to hotweather, making it hard to carry out outdoor infrastructure construction. Onthe other, property investment has yet to pick up, while exports have beenvery weak in the past few months. As the result, FAI growth slowed to 10.3%yoy in July from 11.4% in June. Breaking this down further, manufacturing FAImoderated to 6.9% yoy in July while infrastructure FAI growth eased to 16.2%(left chart). Meanwhile, retail sales growth softened slightly to 10.5% yoy from10.6% yoy in June. Automobile sales remained weak, rising 3% yoy in July vs5% in 1H15 and 8% in 2014.

Diverging property sales and investment: The divergence between weakproperty investment and strong property sales continued. In July, propertyinvestment softened to 2.9% yoy from 3.4% in June, while property salessurged 18.9% yoy in July after rising 16.0% in June. Given the recentrecovery in property sales and prices, we expect property investment toimprove in the coming months.

Policy easing to continue: We expect monetary easing to continue in 2H,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 twoRRR cuts (150bp) in 1H. Meanwhile, fiscal easing should ramp up, supportedby policy bank lending. The impact from fiscal policy will be visible from Sepwhen the weather cools down. One could watch out for cement prices andPMI for green shoots.

RMB under pressure near term: Today’s disappointing data would raiseconcerns on the Chinese economy, thereby adding more pressure on theRMB. We expect high volatility and even ‘over-shooting’ of RMB in the nearterm. But we believe the concerns on ‘currency war’ and ‘competitivedevaluation’ are overblown, given the considerations on capital outflows andupcoming SDR review. According to the PBoC announcement this morning,policy makers seem to expect the pressure on RMB to ease in Sep, when theuncertainty regarding Fed hike removes and the Chinese economy stabilises.

Presently, the PBoC is willing to give market forces more say in RMBexchange rate setting. But if the RMB continues to weaken, the PBoC wouldintervene by selling US$ to support the RMB.