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Matthews Asia: China Surprises

Thursday, July 20, 2017

Matthews Asia: China Surprises

The Chinese economy delivered many surprises in the first half of the year, disappointing (yet again) the pundits who predicted a hard landing. Macroeconomic data published over the weekend is consistent with a healthy economy, driven by impressive wage growth and consumer spending, and supported by strong earnings growth. This issue of Sinology reviews those surprises and looks ahead to the economic and political challenges of the second half of 2017.

Foreign exchange (FX) reserves and currency

In early 2016, the media was full of predictions that by the end of last year, China would run out of FX reserves and its currency would devalue sharply against the dollar. Neither of those events took place, and this year FX reserves have risen and the renminbi (RMB) has strengthened.

China’s FX reserves rose during each of the last five months, increasing by US$46.3 billion during the first half of the year, to amount to more than US$3 trillion. This increase was due to several factors, including tighter enforcement of capital account controls. But the more important reason was the strength of the RMB against the dollar.

The direction of the RMB is determined primarily by the strength or weakness of the dollar, rather than the health of the Chinese economy. In 2016, when the dollar index (DXY) rose 3.6%, the RMB fell by 6.4% against the dollar. In the first half of this year, however, the dollar index weakened by 6.4%, resulting in the RMB appreciating by 2.4% against the dollar.

What to watch in 2H: Capital outflows may accelerate a bit in the coming months as Chinese tourists head abroad and parents pay tuition for children who study overseas. Despite that flow, FX reserves will remain far larger than what China really needs. We expect the dollar to remain fairly soft, so the RMB should continue to strengthen, but Beijing will also continue to intervene to limit the extent of that appreciation against the dollar.

Still the world’s best consumer story

Strong wage growth, low household debt, mild inflation and consumer optimism resulted in real (inflation-adjusted) retail sales growth of 9.3% in 1H17. This compares to U.S. real retail sales growth of 2.3% during the first five months of the year, and we note that while spending by Chinese consumers was equal to only 22% of U.S. retail sales a decade ago, it was equal to 87% of American consumer spending last year and is likely to surpass U.S. retail spending by the end of the decade.

Per capita urban household income rose 6.5% in 1H17, up from a 5.8% pace during the first half of 2016, driven by improved profitability of industrial firms.

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