Moody’s ASIA PACIFIC Economic Outlook

China’s data for the first two months of the year were fairly dismal. Most activity indicators suggest that there are large downward pressures on the economy, which means that the government will need to ease measures if it is to keep the economy growing close to its target.

Industrial production grew just 6.8% y/y in the first two months of the year, down from a 7.9% increase in December. This was due to further weakness in commodity production, especially for crude oil and steel refining. On the positive side, production of electronics and other manufactured goods showed steady growth. The U.S. recovery, in particular, is helping drive China’s exports growth and manufacturing output.

A growing share of China’s manufacturing output is for domestic consumption. Retail sales growth fell to 10.7% y/y for the first two months of the year, but that deceleration was mostly the result of lower prices for fuel and food. Household spending on motor vehicles, electronics and furniture remains healthy. The key downside to watch remains the housing slump, which continues to weigh on investment.

It should be noted that China’s National Bureau of Statistics reports a combined January-February figure for industrial production, fixed-asset investment and retail sales, to strip out the effect of the weeklong Lunar New Year holiday. The Lunar New Year changes dates every year and hence results in distorted year-on-year growth rates when looking at January or February in isolation.

China remains in a low inflation environment, and the possibility of deflation in consumer prices is rising. For this reason, although the People’s Bank of China maintains an officially “prudent” stance, it is shifting to an easing bias. After its February interest rate cut, the tone shifted to note the downside risks of low inflation and how it has pushed up real borrowing costs.

Further easing measures are expected, possibly with a reserve ratio cut in coming weeks, followed by another interest rate cut by midyear. Monetary policy in China remains on the tight side: despite the 50-basis point cut in the benchmark one-year deposit rate, falling inflation means that real borrowing costs (stripping out inflation) are still rising.

Moreover, capital outflows have been compounding a lack of liquidity in the banking sector. Capital flows in and out of China tend to be pro-cyclical. Capital inflows rise in good times and exacerbate problems during asset market bubbles. Capital flows out when conditions deteriorate and compound liquidity shortages.

Source: Moody’s Weekly Market Outlook [19th March 2015]

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