China Macro:March data preview,Expecting a temporary uptick

We expect China’s macro data to improve in March, thanks to base effect andbetter sentiment. Things like PMI, trade and industrial production could allaccelerate compared with the first two months of this year. Thanks to theuptick, we expect 1Q16 GDP growth (to be released on 15 April) to come in at6.7% yoy. Looking ahead, 2Q16 headline yoy GDP growth will likely remain ataround 6.7%.

Data improved on low base and better sentiment: Compared with 2016,the Chinese New Year started 11 days later in 2015 (Feb 8 vs. Feb 19). Itmeans that in early March 2015, the country was still in a holiday mood,resulting in a low base for this year. Meanwhile, investment growth in propertyand infrastructure started accelerating in Jan-Feb and the momentum hascontinued into March. That said, one should not get too excited. Althoughmetal prices have been very strong recently, cement prices, which are lesssubject to inventory stocking and financial speculation, have largely beenflattish in March. It suggests that the recovery in real demand, if any, is stillquite modest relative to what the financial market is telling us.

Limited upside for the recovery: Market sentiment could change muchfaster than fundamentals. Just a couple of months ago, the fears were that ahard landing had already happened in China. But now the emerging views arethat China’s economy is back to firm footing. We think both are overdone. Onone hand, 2016 is the critical year for China’s upcoming power transition.

Therefore, at both top and local levels, leaders would do whatever it takes tomaintain stability. On the other hand, policy makers have no appetite to overstimulateand that’s why they put a cap to growth target (6.5-7.0%). Once theeconomy stabilises, focus immediately shifts from demand-side stimulus tosupply-side reform such as cutting capacity and lowering leverage.

Muted capital outflows pressure in March: Thanks to the dovish FOMCstatement, we have seen eased RMB depreciation pressure as well as lowercapital outflows. The widely watched China’s FX reserves data might drop by$0-20bn in March (to be released on 7 April). As such, the past month hasbeen relatively easy for the PBoC, which is now following this strategy: Ifcapital outflows are big, it sets a stable USD/CNY, which is pivotal for theChinese residents in deciding whether to convert the RMB into USD.

However, if capital outflows are stable, the PBoC then sets the daily RMB ratebased on a currency basket and thereby allows for a more volatile USD/CNY.

Such behaviour reflects the twin targets for the PBoC: maintaining stablecapital flows while reforming the RMB exchange rate mechanism.

Should we worry about inflation? Inflation concerns are gaining tractionamong investors. Although we expect inflation to move higher in March, wethink concerns are overdone. Given the current soft demand, only a strongadverse supply shock could lead to runaway inflation. Such a combination hasnever taken place in China before (it happened in the US in the 1970s).

Instead, higher prices could help boost corporate earnings. Barring a slump inoil prices later this year, China’s industrial profits in 2016 could see its fastestpace of growth since 2013. Regarding policy, since we believe this year’sgrowth would be contained between 6.5% and 7.0%, the constraint on policydue to higher inflation is limited.