China economics

China economics: DBS underscores given China’s prominence globally, how it attempts to resolve the impossible trinity has important implications to all asset classes and economies that depend on China.

Firstly, the house underscores that China should likely maintain monetary policy independence, and either forgo free movement of capital or a fixed exchange rate, given it is a large nation.

If there is a vicious cycle of capital outflows, then DBS sees the Chinese government introducing a large-scale stimulus package that is communicated in detail to offer a conviction to market watchers and to stabilize the real economy.

Otherwise, it could re-introduce capital controls, but this could derail progress made over the past few years, where the Chinese government had put great emphasis on foreign policy with initiatives such as One Belt One Road. Also, this would negatively impact China’s potential accession to the SDR, and is a setback to agendas like the stock connect programs.

A third option is to stop intervening in FX markets, which is a rational choice, because it would preserve China’s foreign reserves, restore competitiveness, and it jives with China’s drive to let markets play a greater role. Nevertheless, China cannot stop intervening immediately because confidence is very low. Doing so could trigger capital ouflows and a sharp drop in the value of the exchange rate.

All in all, DBS sees the most likely outcome being a fiscal and monetary stimulus simultaneously to restore confidence. Concurrently, it could impose selective capital controls and use administrative measures to limit the sale of CNY, buying them some time to resolve the impossible trinity