State of China’s economy:Five surprises in 2017and three questions for 2018

The note includes our updated macro views, Dec data forecasts and amonthly chartbook on the Chinese economy.

    ‘Garbage time’ for now: According to the PMI data released earlier this week(Fig 15 inside), the Chinese economy should remain largely steady toward theend of 2017. However, it tells us little about the year ahead. While 2018 hasalready started, the new year for China macro will only start in March, afterthe Chinese New Year holidays. Moreover, what’s special for this year is thatthe power transition is not yet complete, as key positions such as the PBoCGovernor could be announced any time in the next couple of months. Assuch, visibility for the year ahead remains low at this stage. That said, in thecoming weeks, the last data batch for 2017 will be released (table on the leftsums up our forecasts). So this is a good time to discuss the lessons learnedfrom the surprises in 2017 and the key questions for 2018 (see the last pagefor detailed annual and quarterly data).

    In terms of China macro, 2017 was (again!) full of surprises, but the goodnews is that most of them are positive. In our view, the top five surprises arecurrency, exports, inflation, property sales and financial regulation.

    Unexpected appreciation for the RMB: The RMB is without doubt thebiggest surprise for last year (Fig 45). Twelve months ago, most peopleexpected the RMB to depreciate by 5-10% against the US$ in 2017, but theRMB appreciated 6% instead. Being the anchor of the EM currencies, theRMB’s unexpected strength not only underpins the bull run in HK but also thewhole EM space. The rise of the RMB is due to many factors, but thecombination of capital controls and over US$1.5tn goods trade surplusaccumulated in 2015-17 could play the most important role. For 2018, withexpectations of depreciation much eased, the USD/CNY will likely rangeboundbetween 6.4 and 6.9. Meanwhile, policy makers are set to ease capitalcontrols and relaunch the drive for financial openness.

    Stronger-than-expected exports: It’s under-appreciated that externaldemand was the biggest delta last year for the Chinese economy (Fig 20),with exports likely to have risen 8% in 2017 after dropping 8% in 2016. Weestimate that it could add an additional 1.5ppt to the annual GDP growth lastyear. Strong export growth reflects the unexpected strong performance of theglobal economy, which has never been so synchronized since the financialcrisis. For 2018, with a stronger RMB and uncertainties in the globaleconomy, we expect export growth to moderate to 4% in 2018.

    Soft CPI inflation and strong PPI inflation: At the beginning of 2017, theconsensus was concerned about a potential pick-up in CPI inflation. However,it turns out that CPI inflation was much lower than expected, averaging at1.6% in 2017. Indeed, the undershooting of CPI inflation has been a globalphenomenon and happened in every major economy. Meanwhile, thanks tocapacity cuts and environment inspection, PPI inflation, which averages at6.3% in 2017, is much higher than expected. Looking ahead, we expect CPIinflation to pick up modestly to 2.4% in 2018, with PPI inflation likely droppingto around 3.0%.