Macro Monday:Thoughts on Moody’s downgrade

Last week, MSCI China edged up another 0.2% and the property sectorcontinued to outperform. The most significant movement was of course theUSD/CNY, which ended at 6.816 last Friday, vs. 6.861 at the end of theprevious week.

    Stronger RMB under the new rule: We interpreted the new fixing rule in theprevious issue of Macro Monday titled Yuan could strengthen with the“counter-cyclical factor”. In short, we disagree with the prevalent view that thenew counter-cyclical factor is designed to curb the volatility for the Yuan.

    Instead, we believe the new factor gives more discretionary power to thePBoC, which has a strong incentive to guide the RMB stronger at thismoment. Why? As we discussed in a recent report, given the currentweakness in the US$, a stable USD/CNY could increase the risks for thefuture by worsening the depreciation expectation. Therefore, the PBoC wantsto increase the volatility for the RMB. Moreover, the appreciation also leavesmore room for the RMB to weaken in 2H17, if the US$ appreciates then.

    The economy continues to decelerate modestly: The big picture is that theeconomy peaked in 1Q17 and has decelerated since then. But the slowdownhas been quite modest and GDP growth in 2Q17 is on track for 6.7% yoy(6.9% in 1Q17). Last week, the NBS manufacturing PMI came in at 51.2(previous: 51.2) and the Caixin PMI at 49.6 (previous: 50.3). Sub-indices inPMI suggest that the economy is under disinflation and destocking. Thiscoming Thursday and Friday, China will release trade and inflation data. Weexpect trade data to remain strong at close to 10% yoy, given Korea’sexports, which as announced earlier, were up 13% yoy in May. For inflation,PPI could further drop to 5.8% yoy, given the broad weakness in commodityprices in May (see May data preview: Slowdown continues).

    Thoughts on Moody’s downgrade: Over the past two weeks, we receivedquite a few enquires on China’s country risk, which is under the spotlightagain after the recent downgrade. Below are our brief thoughts on theseissues.

    Regarding debt, we hold a more nuanced view compared with the mainstreamstory which appears every day in the newspapers. Our view is summarized ina thematic report: China’s debt: Myths and Realities. In short, we tend to viewdebt in China as a capital misallocation problem, rather than an impendingcrisis. In the same vein, we view China’s property as a land misallocationproblem, rather than a big bubble (China Property: Mismatch, not a Bubble).

    That said, the past experiences have taught us that it’s a debate which couldnever be settled. After all, even if a pundit started predicting a debt crisis from2010, he/she could still hold such a view today by continuing to say that theday of reckoning is closer and closer. In some sense, it has to be true, as thesize of China’s economy has almost doubled during this period.

    Regarding reforms, back in 2013, we wrote that “financial and fiscal reformswould gain traction after the third Plenum, while breakthrough in land andSOE reform will wait until the 2nd 5-year term for the new government” (link).

    Since then, financial reform has indeed made huge progress and probablygone too far, but SOE and land reforms have made little progress. We are notreally disappointed because we didn’t have high expectations at thebeginning. But our views stay unchanged from four years ago; that reforms inthese areas would see breakthroughs under the new government.