China to face policy dilemma in 2017 in addition to the property bubble – Deutsche Bank

Research Team at Deutsche Bank, expects that the Chinese government faces a policy dilemma in 2017 and believes they will achieve the 6.5% growth target with strong fiscal easing.

Key Quotes

“But this requires further credit expansion, which would exacerbate the risk of property bubble and intensify capital outflows. We expect FX reserves to fall to US$2.8trn in 2017 and $2.4trn in 2018, and USDCNY will depreciate to 7.4 by end-2017 and 8.1 by end-2018 (6.9% and 17.1% from the current level of 6.92). We see macro risks rising beyond 2017, with 50% chance that growth will drop below 6% for a full year sometime between 2018 and 2020.”

“We believe the property bubble is the most important macro issue in China. Land sales accounted for 36% of local government revenue so far this year, and mortgage loans accounted for 43% of new RMB loans (63% in July to Oct). Policies tightened in this sector, property and land sales dropped in Oct, but land auction premium remained high in some cities. This shows some developers continue to expect sharp property price inflation to come. On monetary front, the PBoC may keep the benchmark interest rates stable, but loosen credit supply in 2017Q2 to mitigate the slowdown in property sector.”

“CPI inflation will likely pick up to 2.5% in 2017 from 2.1% in October 2016. Risks to our growth and inflation outlook in 2017 are tilted to the upside, while risks to our rate and RMB forecasts are balanced. We see macro risks to rise beyond 2017. The debt to GDP ratio is set to go up. The property bubble will impose more macro risks, the US rate hikes will further constrain the policy room for PBoC, and the excessive liquidity onshore will likely drive inflation up eventually.”