Market sentiment about China's economy has taken a sharp turn for the worse recently. The RMB weakness that followed the change in the currency's fixing mechanism in August, coming hard on the heels of weak trade and PMI data, has led to concerns over a major downturn or even a "hard-landing". These worries are overblown, The authorities' reaction to the slowdown will be key and a more decisive easing is expected in the next few months.
More importantly, there are bright spots in the economy. Housing sales growth has been accelerating for four consecutive months. Prices in big cities have started to rise again, suggesting that property investment will likely bottom soon. Moreover, Beijing has stepped up easing by speeding up infrastructure project approvals, recapitalising policy banks, and improving local government financing. This should lead to an acceleration in infrastructure investment in the coming quarters. Lastly, there is little sign that the fall in the equity market has hit consumer spending. These positive developments will likely lead to a modest rebound in GDP growth towards the end of the year.
Even if the risks are greater than it is, Beijing could still launch a "circuit breaker" stimulus package to rescue the economy e.g. issuing RMB3-5trn of long-term central government bonds to jump start new projects in the areas of water and air pollution treatment and other urban infrastructure. This would be the equivalent to 2-4% of annual GDP in the coming years.
"We forecast another 50bp of policy rate cuts for the rest of 2015 and 2016. In addition, we expect the required reserve ratio to be cut by another 350bp. On the fiscal side, we expect a bigger fiscal deficit of 2.7% of GDP for 2016", says HSBC.
