Growth steady but headwinds ahead: High frequency data show thatgrowth momentum remained steady in October. We expect China to growaround 6.7% YoY again in 4Q16. Policy stance is moving toward neutral, andthe chance for an IR/RRR cut is very low for the rest of the year. That said,the property sector is showing signs of cooling after 20+ cities rolled outtightening measures in early-October. Growth headwinds might gather afterthe Chinese New Year holidays next January, and in 1Q17 GDP growth couldslow to 6.5%. (See side table for detailed October forecasts.)Stable economy but higher inflation: Industrial production growth, the bestmonthly proxy for GDP growth, could stay unchanged at 6.1% YoY inOctober. The underlying demand remains robust for now as prices for coal,steel and cement all moved higher. Investment growth in October is alsosteady, supported by rebounding private investment and property investment.
On the other hand, inflation should continue to edge up. CPI inflation couldpick up to 2.2% YoY in October (September: 1.9%), while PPI inflation is likelyto rise to 0.7% YoY, mainly on higher commodity prices and a low comparisonbase.
Policy moving towards neutral: With steady growth and higher inflation,policy is set to turn more neutral. Policy makers are also increasinglyconcerned about financial risks and the rocketing property prices in certaincities. Media has reported that the PBoC is considering including off-balancesheetWealth Management Products into their regulatory framework. Inanticipating further policy tightening, liquidity measures in the interbankmarkets, such as repo rates, are edging up recently. That said, the chance foran IR/RRR hike is also extremely low as the underlying economy is still weak.
Moreover, the current growth rates of property and auto sales (up 34% and26% YoY in September, respectively) have significantly deviated from theirlong-term trend, so they are set to decelerate in the months ahead.
Supportive credit and improved trade: In October, we expect new loans todrop to RMB650bn from RMB1,220bn in September, mainly due toseasonality. The share of mortgages (54% of total new loans in 3Q) shoulddrop as the property market is cooling down. That said, loan demand from therest of the economy is improving, as mid- to long-term corporate loansincreased RMB447bn in September after dropping RMB8bn in August.
Meanwhile, we expect trade growth to improve in September thanks to thecurrent reflation trend and a weaker RMB. Looking ahead, both export andimport growth could register single-digit growth in 2017.
FX reserves decline to accelerate in Oct: We expect FX reserves to fallaround US$40bn in October after dropping US$19bn in September, due tocapital outflows and negative valuation effects. So far in October, the pace ofdepreciation has accelerated, as the RMB has dropped 1.7% against theUS$. The fall is mainly due to the surge of the dollar index (up 3.4%), whilethe RMB is largely stable against a basket of currencies. For the rest of thisyear, the trend for the RMB still largely depends on the dollar index, which hasalready reached 98.7, close to the peak of 100.5 last December. The recentdepreciation suggests that, as capital outflows are under control, the PBoC isready to allow for higher volatility for the USD/CNY. However, if capitaloutflows increase too fast, we expect the PBoC to intervene to stabilize thecurrency.
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