China Macro:China 2016Outlook:Deceleration,Divergence and Dollar

We see 2016as a year of ‘3D’: Deceleration: China would continue the longgrinding landing, with GDP growth slowing to 6.7% in 2016and 6.5% in 2017.Divergence: Beneath the headline number, wide divergences would happen inmany areas due to structural changes in the economy. Dollar: RMB could facefurther depreciation pressure against the dollar in 2016and China’s FX reservescould drop another US$400bn.

Three long cycles: Politics, Growth and Liquidity

Three multi-year macro waves will cast a long shadow in 2016:(1) Politicalcycle with continued power consolidation, implying that stability remains asthe priority and hard reforms would take a back seat;(2) Growth cycle withlower gear and changing engines, suggesting that views toward China wouldcontinue to diverge widely, depending on which areas one is focusing on;(3)Liquidity cycle with capital inflows turning into outflows, as liquidity hasbeen the key driver for China’s market and economy over the past few years.

Top themes in 2016: Finance, RMB, Debt and Divergence

(1) Financial reform: including the phase-in of a new monetary policyframework; development of direct financing (bond and equity); capital accountopenness; and loan securitization.(2) RMB and capital outflows: In 2016, RMBwill likely weaken another 3-5% against US$, assuming 5-10% appreciation ofthe dollar index in 2016; if capital outflows worsen, the PBoC would step upintervention. Meanwhile, we will see higher volatility of RMB going forward.(3)Debt restructuring: The government would continue to restructure the existingdebt, following the principle we call ‘leveraging up the central government andhouseholds; deleveraging local governments and corporate’.(4) Divergence:Performances of various segments of the economy would diverge widely and wediscuss five of them in the note.

Top risks in 2016: Credit, liquidity, USD

We see three risks in 2016. First, more credit events could happen in thecorporate bond market and P2P lending. Second, liquidity risk could arise frominadequate response by the PBoC to capital outflows. Third, the USD is anuncertainty. A stronger-than-expected USD would weigh on commodity pricesand worsen deflation in China. It could also increase the RMB depreciationpressure and capital outflows. A weaker USD would do the opposite.

Main economic and policy forecasts for 2016

Besides the above-consensus 2016GDP forecast of 6.7%, we see a smoothquarterly growth trajectory due to policy support. In terms of growth momentum,1H16would be weaker than 2H16. Quasi-fiscal measures, such as policy banks,PSL and PPP, would play a bigger role. With muted inflation pressure in 2016,the PBoC will continue to focus on “twin balances”. For external balance, it coulduse currency intervention and capital controls to stabilize capital outflows. Forinternal balance, it will continue the current easing cycle with two interest ratecuts (25bp each) and 300bp RRR cuts in 2016. Key interest rates such astreasury yields and Wealth Management Product yields would further trenddown, while credit spreads could rise in 2016(see last page for our detailedforecasts on 2016).