4 Wall Street predictions for China in 2016

As Wall Street looks to predict the global economic outlook in 2016, one of the top questions is uncertainty regarding China.

It is no exaggeration to claim that if China sneezes, the world catches a cold. “The single largest risk to global growth is that activity in China slows more sharply than we currently predict and takes the world with it,” analysts at Citi Research wrote. “China is transitioning both from a manufacturing-led to a consumer-led economy, and from a state-directed to a free market. Both shifts will create uncertainty over China’s growth path and the outlook for capital flows,” UBS wrote in its 2016 investment outlook report.

What will happen to the world’s second largest economy in 2016? Below is a round up of Wall Street bankers’ predictions:

GDP growth will slow further, but it won’t crash

Make no mistake: China is going to slow, but Wall Street doesn’t think it will crash in 2016. Analysts at Barclays Research forecast 2016 GDP growth to slow to 6%, while UBS analysts have a slightly more optimistic prediction of 6.2%. Citi Research, more bearish on the growth rate, pegs their estimates of true growth at just above 5%. Yes, there’s no doubt that China faces many problems ranging from the high leverage in the economy to rising labor costs. But Wall Street remains optimistic of the government’s ability to handle the transition. A Lehman-style collapse of the financial system would also be unlikely given the government’s resources to backstop the financial system. “Long term, we remain bears, and see a high risk of a hard landing, but near term there are signs of stability,” according to a Credit Suisse report.

More rate cuts down the road

After lowering interest rates repeatedly in 2015, China is still likely to continue its monetary easing policy to contain its economic slowdown. One reason is deflation pressure created by weakness in growth. Barclays Research predicts two more 25 basis points benchmark rate cuts in the first half of 2016, given the need to support sentiment and reduce debt burdens. But analysts at Citi point out the need to revamp the country’s policy rate and money market intervention mechanism in order to make rate cut more effective. “In an economy now subject to sustained capital outflows, easier monetary conditions lose effectiveness if the exchange rate is not allowed to move, as much of the additional liquidity injected by the central banks flows out of the country through reserve losses and capital outflows,” wrote analysts at Citi Research.

The yuan will continue to depreciate

2015 was a significant milestone for yuan, as the IMF officially agreed to include the Chinese currency in the benchmark SDR basket. On December 11, the People’s Bank of China signaled its intention to peg the yuan to a basket of currencies instead of just U.S. dollar, which could allow room for the Chinese currency to fall. Analysts at Barclays expect the dollar-yuan exchange rate to drop to 6.8 by mid-2016.

Capital outflows will continue to rise

In recent months, the government has imposed increasingly strict measures to limit unofficial capital flight. Non-FDI outflows surged in the third quarter in 2015 after the People’s Bank of China moved to a fixing regime for yuan in August this year, according to Barclays. The combination of slower domestic growth and the bias towards overseas investment will likely contribute to further capital outflows, which could create further pressure on foreign exchange reserves. Citi Research predicts that this could result in even more benchmark rate cuts and further depreciation of the yuan.

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