China Macro-May data preview:Stable economy and policy with renewed capital outflows

The Chinese economy looks steady in May. We expect largely flattish PMIand industrial production growth, in line with around 6.7% GDP growth in2Q16and the so-called ‘L-shaped’ pattern. As such, policy will stay put in thenear term. Concerns about CPI inflation and PPI deflation will both easefurther. That said, the recent strengthening in the USD could cause China’sFX reserves to drop again in May after rising for two months, rekindlingworries about the currency (see side table for detailed forecasts).

Stable economic growth: While power production seem to have softened,cement prices continued to rise, pointing to robust demand from the propertyand infrastructure sides. Meanwhile, fixed asset investment growth shouldalso be largely stable. Export growth improved in 2Q16(-1% yoy vs. -10%)due to a lower base, but external demand showed few signs of a near-termturnaround. Overall, the current economic data is largely in line with thegovernment’s growth target for this year. As such, policy stance will likely stayput and the chance of a near-term interest rate cut is very limited, althoughanother RRR cut is still possible in June.

Easing inflation concerns: Earlier this year, investors feared that Chinawould face runaway inflation. Such a concern has proved overdone as thesupply of vegetables has picked up and prices fell. We expect CPI inflation tohave edged down to 2.2% YoY in May (Apr: 2.3%), and we see limitedchance of it rising above 2.5% for the remainder of this year. Meanwhile,despite the recent drop in industrial metals prices, we expect PPI deflation tohave narrowed to -3.3% YoY in May (April: -3.4%) thanks to a very low base.Looking ahead, if oil prices stay at around $50/bbl as our oil team forecasts,PPI deflation will continue to narrow in 2H16.

OK new loans after adjusting for debt swap: These days it is getting harderto read China’s credit data because new loan numbers are distorted by localgovernment debt swap. For example, new loans this April totalled Rmb556bn,much lower than Rmb708bn in April 2015. However, adding the overRmb350bn debt swap back, new loans in April totalled ~Rmb900bn, whichwas not that disappointing albeit less exciting than the credit binge in 1Q16. InMay, we expect new loans to be Rmb650bn vs. Rmb901bn last May, but it isnot that bad if debt swap is taken into account. Meanwhile, M2growth willslow to 12.6% YoY in May, in our view, as the PBoC lately warned that itwould drop further in the months ahead, due to a higher base caused by thestock market rescue last July, when the PBoC printed money to buy stocks.

FX reserves to fall in May: Given the renewed strengthening in the USDgoing into May, capital outflows will pick up again. CNY spot has depreciated1.2% against the USD in May, giving back most of the gains in the prior threemonths. China’s FX reserves, due on 7June, could see a modest drop ofUS$30bn after rising in March and April. Looking ahead, the PBoC willcontinue to let the RMB follow USD strength, in our view. The RMB shoulddepreciate against the USD if the dollar index continues to rise on theexpectation of a Fed hike in summer. Key for the PBoC is to manage marketexpectations with better communication this time, so that market response isless volatile than it was last January and August. As with six months ago, wecontinue to expect the USD/CNY to hit 6.6at the end of 2016.