Our China Vulnerability Sentiment Index (CVSI) improved in August, underpinned by gains in the SOE, Housing and Shadow banking component while FX speculative pressures persist despite slowing capital outflows. July activity data signalled near term moderation in growth momentum, following a solid first half. The softer macro data cuts across production as well as demand side indicators, led, in part, by the lagged effect of financial deleveraging. While credit flow is increasingly sustained by formal bank lending, moderating growth of Wealth Management Products and curbs on shadow credit is weighing on overall demand.
Progress on regulatory policy coordination ensures visible gains in August CVSI
The improvement in August CVSI (Figure – 1) reflects progressive and broadbased policy efforts by Chinese authorities to control shadow banking related risks and leverage while underpinning growth stability at the same time. Following transmission delays, the real impact from financial deleveraging on China’s activity, housing market and credit indicators, is expected to be increasingly evident going forward. Gains in our SOE vulnerability Index (Figure – 2 and 7) reflects a pick up in profitability in July mainly driven by improving efficiency at the petroleum refining, coal and steel industries. Meanwhile, a slowdown in home sale area and moderation in real estate investment in light of tighter regulations kept Housing Bubble vulnerability Index (Figure – 3) in check. China’s average new housing prices have slowed for the 6 straight months now. A notable improvement is seen in our Shadow Bank Vulnerability Index (Figure – 4), which reflects the ongoing rotation away from shadow banking to traditional bank financing as a part of policy efforts to repair financial fragilities in the system. With broad total social financing growth holding up, policymakers are ensuring a soft-landing in economic growth going ahead. Finally, our Exchange Rate Vulnerability Index (Figure – 5) suggests FX speculative pressures persist despite slowing capital outflows and a notably stronger and stable Yuan. While tighter capital controls have effectively restrained outbound FDI, Chinese households are still diversifying assets abroad. Also, Chinese corporate foreign debt reductions, which accounted for the bulk of capital outflows over past years, has reversed course. We continue to expect PBOC’s prudent approach to actively manage interbank liquidity to stem funding pressures and underpin Yuan stability going forward.