China Macro-December data preview:Growth stable,policy tighter and PPI higher

2016 will be remembered for black swans, which by definition is: (1) asurprise; (2) a major event; (3) rationalized by hindsight. According to thedefinition, China’s economy in 2016 was a black swan. At the beginning of2016, the most eye-catching topic was whether China’s hard landing hadalready happened. At the end of 2016, the Chinese economy once againdefies doomsayers and the major concern has shifted to inflation. While allthese could be justified by policy and property, the big swing highlights howhard it is to forecast the world’s second largest economy. With this in mind,below is our last data preview in the eventful 2016.

Economic growth to end 2016 stable: High frequency data suggests thatindustrial production growth could be 6.1% yoy in Dec (Nov: 6.2%). As such,4Q16 real GDP growth will again hit 6.7% yoy, same as the previous threequarters and in line with our 2016 Outlook. That said, as China is entering aproperty down-cycle, the economy will feel much stronger headwinds in themonths ahead. While media has recently reported that President Xi is open togrowth falling below 6.5% (link), it is more likely that policy makers willmaintain a relatively stable growth trajectory around 6.5% in 2017 for thepolitical transition, but will accept more bumpy growth beyond that to carry outlong-awaited and painful reforms.

Monetary policy with a tightening bias: In the recent Central EconomicWork Conference (CEWC), policy makers made it clear that monetary policystance is ‘neutral’. With the economy stable at this moment, the focus ofpolicy is to deleverage the bond market. After all, the last thing top leaderswant to see amid the political transition is a market crash like the stock rout in2015. As such, 10-year treasury could stay at 3-3.5% in the next six months(below 3.0% most time in 2016) until the current policy stance changes againon growth headwinds and moderated inflation, likely around mid-2017.

Lower CPI and higher PPI: We expect CPI inflation to ease to 2.1% yoy inDec (Nov: 2.3%). However, CPI inflation could jump to above 2.5% in Jan,due to the Chinese New Year, but fall below 2% in Feb. Overall, we expecthigher CPI inflation in 2017, which could average 2.4% for the whole year(2016: 2.0%). Meanwhile, PPI inflation could rise further to 4.2% yoy in Dec(Nov: 3.3%), given the low base and higher commodity prices since Oct. Baseeffect will likely drive PPI inflation to above 5% in 1Q17, which could forcepolicy makers to ease supply controls. Going into 2Q17, however, we expectthe trend to reverse. PPI inflation could average 2.6% in 2017, vs -1.5% in2016 and reflation will stay as a major theme for 1H17.

FX reserves to fall below US$3trn: Until Nov, China’s FX reserves were$3.05trn, compared with $3.33trn at end-2015. This could drop anotherUS$60bn in Dec, due to adverse valuation effects and capital outflows. On thepositive side, the total drop of US$340bn in 2016 was much smaller than themarket expected, and even smaller than our more sanguine forecast ofUS$400bn in 2016 Outlook. However, the break of an important psychologicalthreshold and the new US$50k quota available next Jan could put morepressure on the Yuan in the new year. Under the new US President, currencywill be a major topic in US-China relations, which could be a source of blackswans in 2017. Meanwhile, a joyful holiday and a Happy New Year!