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July 20, 2016

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Moderate growth ahead as less policy support

CHINA’S gross domestic product growth came in stable at 6.7 percent year on year in the second quarter, unchanged from the pace in the first quarter. While it came in broadly in line with our expectations, details of the June activity data came in stronger than expected, suggesting that economic activity picked up momentum towards the end of the quarter.

The upside surprise in June activity momentum, including industrial production, retail sales and exports, is encouraging, especially considering that there was one less working day in June this year, as macro policy support since late last year continues to feed through to the economy. Meanwhile, some latest developments are worth highlighting.

First, private sector investment growth eased further, rising at a modest 2.8 percent in the first half, versus 3.9 percent in the first five months. In particular, private investment in the north east region contracted 31.9 percent during the January-June period, reflecting the ongoing drag from the adjustment in the overcapacity sectors. From the industry perspective, it appears investment in the traditional industries, such as mining and metals have underperformed significantly, while investment in the new and services industries, such as IT, healthcare, as well as environment management, outperformed notably. Besides, the significant upward momentum in some indicators seen in recent months, such as the strong new investment projects started and the notable housing sector recovery, seem to be peaking off lately.

Looking ahead, as the impact of the earlier round of policy support peaks off, we expect GDP growth to ease modestly in the second half. The full-year 2016 economic growth forecast remains unchanged at 6.7 percent. On the positive side, the further narrowing in Producer Price Index deflation and improvement in corporate profits, as well as solid growth momentum in new sectors, such as high-tech, services, will likely continue into the second half.

On the policy front, we expect the government will maintain an expansionary fiscal policy and a neutral monetary policy in the rest of the year, with a slight bias toward easing if growth slows down. On the fiscal front, China’s augmented fiscal deficit will pick up modestly from 9.7 percent of GDP in 2015 to 10.1 percent of GDP in 2016, biased towards even higher. Meanwhile, monetary policy will likely be neutral and credit growth will be stable. The government has no incentive to adopt a monetary stimulus, but it also does not want a monetary tightening to jeopardize the ongoing modest recovery. We expect one 25 basic point rate cut in the rest of the year, most likely in October, and two reserve requirement ratio cuts in the second half of 2016 to enrich the market liquidity.


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