The CPC Politburo will hold a meeting in late July to analysis the current economic situation and arrange the economic work for 2H19. The latest economic data showed that the Chinese economy was stable overall and operating in a reasonable range in 2Q19, and the performance in June was better than market expectations. We expect macroeconomic policies to seek a balance between “supporting growth” and “controlling risks” in 2H19. We believe the government is likely to keep monetary policy neither too tight nor too loose, continue implementing tax and fee cuts, and remain vigilant against rises in housing prices.

The Chinese economy was stable overall in 2Q19 and economic data in June outperformed the market expectations. China’s real GDP growth slowed from 6.4% in 1Q19 to 6.2% in 2Q19, but nominal GDP growth accelerated from 7.8% to 8.3%. YoY growth in industrial value added and retail sales jumped from 5% and 8.6% in May to 6.3% and 9.8% in June, much better than market expectations of 5.2% and 8.5%. Overall, the economy continued to slow but still operated in a reasonable range in 2Q19. China and the US restarted trade talks after the G20 summit in Osaka, mitigating external risks, but whether the two sides can reach an agreement remains to be seen. We think the Politburo will focus on the downward pressure on the economy at its July meeting.

We believe China is likely to keep monetary policy “neither too tight nor too loose”, and an interest rate cut by the US would provide more room for China’s monetary policy. The weighted average interbank pledged repo rate in June was 1.74%, down 0.53ppt from that in May. Interbank liquidity is overall loose. However, the credit spreads of interbank certificates of deposit have widened and the repo rates at exchanges have risen since the takeover of Baoshang Bank, indicating a tightening of the financing environment for small/medium-sized banks and non-bank financial institutions. Looking ahead, the Fed is likely to cut interest rates at end-July and China’s central bank may also slightly lower interest rates in open market operations. We believe domestic interbank liquidity is likely to remain adequate.

In terms of fiscal policy, we believe China is likely to continue implementing tax and fee cuts, while maintaining a balance between fiscal revenue and expenditure. Value-added tax (VAT) revenue growth slowed sharply in 2Q19 after the VAT rates were lowered in April. Social insurance contribution revenue growth also slowed after the contribution rates were reduced in May. We believe the tax and fee cuts will continue to produce effects in 2H19, boosting consumption and investment. This year’s local government bond issuance is scheduled to be largely completed by end-September, which should support infrastructure investment growth in 2H19. The general public budget and the government-managed fund budget combined recorded a deficit of Rmb2.1trn in 1H19, a significant expansion from the Rmb415.4bn deficit a year earlier. The annual budget suggests a potential deficit of Rmb4.35trn in 2H19. The substantial tax and fee cuts may lead to some fiscal pressure in 2H19. The government may achieve a balance between revenue and expenditure by collecting more profits from SOEs, making use of idle funds, and reducing general expenditures.

In terms of real estate policy, we believe the government will remain highly vigilant against rises in housing prices. Real estate investment and new starts in GFA terms increased by double digits in 1H19, and land in tier-1/2 cities was purchased actively at premium. Latest data showed that new-home prices in 70 large and medium-sized cities in June rose 10.8% YoY on average. Recently regulators tightened the control over real estate trusts[1]. To control real estate companies’ foreign debt risks, the National Development and Reform Commission (NDRC) required that the foreign bonds issued by real estate companies can only be used to replace their medium/long-term foreign debts due in the next year[2]. We think the Politburo will require further implementation of long-term real estate market mechanisms under the principle of “housing is for living in, not for speculation”.

To sum up, we expect both stability and flexibility in macro policies. If external uncertainties rise again in 2H19, the government may step up counter-cyclical policy support. If China and the US reach an agreement and the downside risks to the economy alleviates, the government may make more efforts to control and resolve financial risks.

[1] http://www.eeo.com.cn/2019/0713/361110.shtml
[2] http://www.ndrc.gov.cn/zcfb/zcfbtz/201907/t20190712_941421.html