Expect even more monetary and fiscal stimuli as the Chinese economy keeps on decelerating

The Chinese economy is still on a slowdown path with worsened business sentiment. Both the manufacturing and non-manufacturing PMIs dropped in July 2018. Chinese firms continued to delay their investment as the fixed asset investment continues to fall and reach a historical low at 5.5%. Most of the decline in FAI was due to the stagnant growth of the tertiary sector, especially in infrastructure. The retail sales dropped to 8.8% YoY on July, which is not only significantly lower than the previous year (10.4%), but also the second lowest rate for 2018. However, the service related sales, e.g. the medical and housing components, still saw solid growth, helping to stabilize consumption growth. On the external front, China’s exports grew steadily at 12.2% YoY, but import growth soared further at 27.3% YoY, narrowing the trade surplus. While the increase in imports seems to contradict with the escalation of the US-China trade war, it may largely reflect the rising energy prices and the front loading imports to avoid incoming tariffs. Hence, we expect a downward correction in both exports and imports. The general price level in China still remains under control (CPI: 2.1% YoY & core CPI: 1.9% YoY). This allows more room, beyond the already relatively lax monetary conditions, for the PBoC to accommodate the likely fiscal expansion. As we argued in our earlier note, the duo expansion in both fiscal and monetary policies will be the most likely policy scenario for 2H18. In this vein, M2 grew more in July (8.5% YoY) and new loan growth was also higher than expected. However, shadow banking does not seem to be favoured in this laxer environment, at least based on the poor growth of total social finance even after its expanded definition introduced by the PBoC . To offer an overall accommodative environment, the PBoC may have to accelerate its injection of liquidity to the market beyond the official banking sector. Against the backdrop of laxer monetary conditions, the PBoC first intervened in the market by imposing reserve requirements on FX forward transactions, followed by acknowledging officially the continued usage of the countercyclical factor to determine the RMB daily fixing. We believe these supported the RMB away from a depreciatory slide until mid-August. However, the current appreciation trend, which is strongly supported by the PBoC's intervention, may be limited by China's weakening fundamentals and the trade war in the future. Finally, although the strict government stance on real estate remained, housing prices continued to be robust across different tiers of cities as investors expect softer liquidity condition can support property prices. Housing rents also surged in major cities, such as Beijing, Shenzhen and Chengdu, which should gradually pass through to consumer prices. All in all, the Fed’s interest rate hikes and the escalation of the trade war will remain the key negative factors affecting the Chinese economy.