Chinese stocks traded lower yesterday as investors speculate that the lower demand for new homes in China may cause prices to fall and hurt developers. The China A50 index lost 1.6% over the past four trading days to close at 6,652.82, 1.1% below its 50-day moving average.

Macquarie Equities Research (MER) issued a report on the Chinese economy on 2 June, after its announcement of the official Purchasing Managers Index (PMI) for May which indicated an expansion in the economy. Here are some excerpts from the report.

The official PMI improved in May, rising to 50.8 from 50.4 in April (consensus: 50.7). It should not be too surprising to the market as the HSBC flash PMI released ten days ago already showed a notable increase in May.
 
Thanks to mini-stimulus measures, China’s GDP growth in 2Q14 will likely come in better than MER’s forecast of 7.1% yoy, and lower than the actual reading of 7.4% in 1Q14.
 
…with mixed market implications: At this stage, the Chinese economy is still faced with significant downside risks, as the property sector is under a down-cycle. As such, a modest improvement of economic data might not be enough to convince the market that an upturn in the current mini-cycle, reminiscent of Sep 2012 and July 2013, is just around the corner.
Rather, macro could remain directionless for a while, stuck in a tug of war between weakening fundamentals and government stimulus. Subject to sentiment and fund flows, better macro data could be interpreted by the market as a sign of stabilization or waning stimulus.
 
More mini-stimulus are under way: Last Friday, the State Council announced another mini-stimulus measure: a targeted Reserve Requirement Ratio (RRR) cut for banks whose lending to small enterprises and rural sectors is beyond a certain ratio (the impact could be not quantified now without details from the PBoC). By nature, it’s similar to other measures released in the past ten days, such as Local governments to quicken fiscal spending (May 28) and RMB300bn relending from the PBoC for shanty town projects (May 22), as well as the previous targeted RRR cut for rural banks in April.
 
The logic behind mini-stimulus: In the past, China’s policy makers tended to err by doing too little in preventing growth slowdown, then err by doing too much in fighting fires. New leaders seem to take lessons from it. That’s why this time they are more proactive in stimulating the economy, even if the incoming economic data are still OK. However, with current data, there is little ground to stimulate the economy in a big way. That’s why they try to avoid any high-profile policy measures including broad-based RRR cuts.
 
The one million dollar question for policy makers and the market: That is, are the existing mini-stimulus measures enough to turn the economy around? Because policy has time lags, no one knows the answer at this stage. That said, with the stabilized economy, MER believes policy makers will more likely take a wait-and-see strategy and stick to mini-stimulus in the near term, refraining from high-profile monetary easing.
 
MER still expects RRR cuts later this year, even not for stimulus. Indeed, MER pencilled in two RRR cuts in their 2014 outlook published last Nov, without stimulus in mind. MER just reckoned that RRR cuts are needed to compensate for the fall of capital inflows. Note that China’s FX reserve could only increase by US$200bn in 2014 (vs. US$500bn in 2013). The shortfall of US$300bn (RMB1.8tn) could be compensated by three 50bp RRR cuts (a release of RMB500bn each) complemented by some open market operation. Currently, Beijing still hesitates to do so, instead it relies on targeted RRR cuts and relending facility by the PBoC. However, the former is too opaque to the market in terms of guiding expectations. The latter essentially is to ask the PBoC to expand its balance sheet to finance fiscal spending, which is not very advisable in modern central banking practices.

Source: Macquarie Research - 5 Jun 2014