Interbank liquidity has tightened further in the past few weeks, mainly driven by the step-up in regulatory efforts towards financial deleveraging since late-March. Meanwhile, we have seen some early signs of moderation in domestic demand growth in April, including a pull-back of mfg. PMI, sell-off in commodity markets, as well as slower import growth and widening trade surplus. Many investors worry that the ongoing regulatory tightening will lead to prolonged disinflation and growth slowdown, i.e. a “mini version” of 2013. In this note, we share our thoughts on the potential impacts of the ongoing policy adjustments and its transmission to real economic growth.

The ongoing liquidity tightening has led to visible adjustments in domestic financial asset markets, particularly those of bonds and commodities. Meanwhile, growth momentum appears to have softened since April.

In the near term, continued policy emphasis on financial deleveraging – particularly stricter regulations around WMP and interbank CDs – may continue to exert downward pressure on financial asset prices, especially fixed income products. Moreover, small-medium banks & other financial institutions with higher leverage may continue to feel the pinch. In the medium term, there is still room for long term yields to move up, including those of treasury & credit bonds.

Meanwhile, we may witness a “soft patch” in domestic investment growth in coming months, as a result of tighter financial conditions and reduced inflationary expectations.

However, we see some important differentiating factors compared with 2013, which will likely mitigate the slowdown in economic growth and curb the deflationary pressure.

Both nominal & real interest rates are notably lower than in 2013.

Fiscal investment pipeline remains strong, domestically & abroad.

Monetary expansion is already slower than/close to the pre-set targets, as opposed to 2013.

Policy coordination has improved.

We are standing in much healthier positions in the manufacturing capacity and property inventory cycles.

External demand growth is picking up.

Looking forward, we will closely monitor changes in the real interest rates and the growth of adjusted TSF, in order to gauge the potential impact on growth and inflation from the ongoing liquidity tightening & financial deleveraging. The risk to our more constructive outlook is potential policy missteps that results in over-tightening of financial conditions for the real economy.