China negativity overdone? – Westpac

Sentiment on China has soured in recent weeks as weaker data, tighter financial conditions and a debt downgrade have all played their part, according to Richard Franulovich, Research Analyst at Westpac.

Key Quotes

“While there’s no doubt that China faces a Herculean long term structural adjustment negativity around the near term outlook may be overdone. For one, a simple model of Chinese industrial production based on lagged values of real interest rates, the real effective exchange rate and total social financing does not yet signal a meaningful downturn.”

“On the contrary, our simple model of Chinese industrial production continues to point to accelerating growth.”

“Among the inputs to the model, real interest rates have indeed risen and will likely remain higher thanks to low inflation and as authorities continue to wring out credit excesses.”

“But, that is offset by a real effective exchange rate that has been on a clear depreciation track of late. After falling 6.1% last year, China’s CFETS basket is down another 1.6% year to date. Against that an unweighted backset of the nine major East Asian currencies (excluding JPY) fell just 1.5% in 2016 and 2017 year to date has appreciated 3.8%. The recent shift in the CNY trend bears watching though - if sustained, this input will shift from being a tailwind to a headwind.”

“Total social financing (+9.3% annual growth as of April) is consistent with decent industrial production outturns too, even allowing for the fact that growth is overstated by double counting.”

“Overall, caution is understandable but on  balance the key drivers of a simple top-down IP model suggest the recent cooling on China's prospects may be overdone.”