Key financial market driver 3 - China growth outlook
Key questions
e When will the economy bottom out?
e What economic policy responses can we expect to support the economy ahead?
e How significant is the contagion risk from a possible downturn in the Eurozone?
ClO View (Probability: 70%*) Modest policy easing to support growth in 2H12 e The latest economic data suggest that economic activity is showing signs of stabilization, albeit at a comparatively low level. However, we have yet to see meaningful pick-up in activity. We think that policy measures to support the economy should have more visible effect on activity in the second half of the year.
¢ To this effect, the People's Bank of China (PBoC) has recently cut interest rates by 25bps — the first such move since late 2008. With investment demand still sluggish, we don't expect the measure to have a significant near-term effect on growth. Still, the cut confirms the leadership's commitment to support the economy. Importantly, with the rate cut, measures were announced to increase the banks’ ability to set interest rates, which should bolster private household spending power in the future.
e The rate reduction took place against a backdrop of falling price inflation. Thus, inflation is no obstacle for further measures to ease monetary policy. However, at this point we don't expect further rate cuts this year; especially since increased interest rate flexibility should contribute to an easing of monetary conditions ahead. If anything, we think the PBoC may implement more reductions in banks' reserve requirement rates to ensure sufficient liquidity provisions. Thus, we think the real focus has to be on the fiscal policy measures now, including possibly an acceleration of infrastructure investments, measures to support consumer spending and selective relaxation in the property market (while keeping home-purchase restrictions intact).
A Positive scenario (Probability: 20%*) Higher-than-expected growth
¢ Chinese GDP grows above 8.5% in 2012. For this we would probably need to see stronger-than-expected fiscal and monetary policy support from the government. A speedy improvement in the Eurozone debt crisis could also lead to this positive scenario.
& Negative scenario (Probability: 10%*) Hard landing ¢ Chinese GDP growth below 6%, i.e. a hard landing of the economy. This could be triggered by a global financial crisis/recession, causing a slump in Chinese exports. Other risks include a sharp decline in Chinese residential property prices — which would slow investment growth, a large-scale default of local government debt, or a surge in inflation that forces the PBoC to significantly tighten monetary policy.
Key dates 1 Jul Manufacturing purchasing managers index (Jun) 13 Jul Fixed asset investment, industrial production lun), 2Q12 GDP
11-15 Jul New bank lending, M2 Gun) 22-25 Jul HSBC flash manufacturing purchasing managers index (Jul)
a UBS For further information please contact CIO analyst Gary Tsang, gary.tsang@ubs.com, Glenda Yu, glenda.yu@ubs.com, Patrick Ho, patrick-ww.ho@ubs.com
First interest rate cut since 2008
8
un-03 un-04 un-05 un-06 un-O7 un-08 un-09 un-10
un-11 un-12
=== |-year lending rate ——= 1-year deposit rate
Source: Bloomberg, UBS CIO, as of 18 Jun 2012
Pick-up in infrastructure investment
armima
oe, Ho, 1 3
A ie li
Year-on-ye ar
i HM
¥
Source: Bloomberg, UBS CIO, as of 18 Jun 2012 Note: Past performance is not an indication of future returns.
* Scenario probabilities are based on qualitative assessment.
10
Please see important disclaimer and disclosures at the end of the document.
HOUSE_OVERSIGHT_024145