Wednesday’s Budget provides a small additional fiscal stimulus in the near term, but shows significantly worse projections for the public finances than in November’s Pre-Budget (with the fiscal stimulus measures announced playing only a very small role in this). The projected gilt issuance numbers for this year, and the DMO’s illustrative financing projections for the next few years beyond that, imply very large gilt issuance for several years to come. With limited additional fiscal tightening announced in this Budget, we now think there are upside risks to our gilt yield forecasts (we currently forecast the 10Y gilt yield at 4.6% at end-2009 and 5.1% at end 2010) and that the curve is likely to remain under steepening pressure for a prolonged period. Fiscal Stimulus in the Short Term The Budget shows additional net fiscal stimulus for 2009/10 of roughly £5 billion (around 0.4% GDP). That is not a great deal of aggregate fiscal stimulus; however, the measures are very targeted at tackling some of the areas of most concern. These measures are also in addition to the much bigger stimulus from November’s Pre-Budget. Measures announced in the Budget include help for the jobless (including more funding for the Department for Work and Pensions), homeowners and housing supply (including an extension in the government’s shared equity scheme), the car scrappage scheme (costing around £300 million) and some measures to help businesses (including deferral of business rates). Near-Term Deficit Numbers Higher than We Had Projected The forecast for public sector net borrowing (the deficit) was higher than we had expected. The government expects a deficit of 12.4% GDP in 2009/10 and of 11.9% in 2010/11. The receipts projection was in line with our forecast for 2009/10, but projected expenditure is higher than we had originally forecast. The Treasury forecast total Public Sector Net Borrowing (the deficit) to be £175 billion in 2009/10 (that’s nearly £60 billion higher than in November’s Pre-Budget). The deterioration in forecast is overwhelmingly due more to the predicted deterioration in the economy (lower cumulative real growth and lower inflation than predicted in the Pre-Budget) rather than to the stimulus measures announced in this Budget. GDP Growth Assumptions Look Optimistic Beyond 2010 The Treasury builds in a more pessimistic forecast than we have for the economy over the near term (as expected, forecasting -3.5% GDP growth in 2009), but a stronger forecast beyond 2010. Taking a three-year average of the growth forecasts, their numbers would probably look somewhere in line with ours. However, their projections for growth (incorporated in their fiscal projections) for 2011/12 onwards incorporate a very optimistic-looking 3.25% GDP growth. This partly reflects their assumption that trend growth is around 2.75% (and that the crisis has resulted in a big hit – of 5% – to the level of potential output rather than its growth rate). Our own best guess for potential growth (from January’s Green Budget publication) for 2011 and 2012 by contrast was only 1.8%. They also observe that recoveries from past recessions have been relatively strong. Effectively, the Treasury has built in a central assumption that policy stimulus works (including what strikes us as a relatively strong central assumption that quantitative easing from the Bank of England lifts the level of nominal GDP by 5%). In the Budget, the Treasury acknowledges an exceptional amount of uncertainty around the judgments underlying its economic forecasts. While over a three-year horizon (averaging out), the Treasury’s forecasts do not look too out of kilter with our own; beyond that point the Treasury’s forecasts look to be on the optimistic side. Disappointing Amount of Medium-Term Fiscal Tightening There wasn’t all that much in the way of additional announced future fiscal tightening, with measures appearing to amount to about £5 billion by 2011/12. These included additional fuel duty increases and a 50% tax rate for individuals with incomes over £150,000 (each measure worth almost £2 billion a year by 2011-12). This relatively limited future fiscal tightening comes as a disappointment – the deficit improves only very gradually (and is still at a massive 5.5% of GDP in 2013-14). This leaves the stock of net debt projected at 55.4% of GDP in 2009/10 (ex-liabilities and unrealised losses on financial sector interventions) and still not falling by 2013-14 (76.2%). In his speech, Chancellor Darling suggested that this would fall from about 2015/16. Including the Treasury’s figure for unrealised losses on financial sector interventions leaves projected public sector net debt at 79% of GDP by 2013-14. Much Higher Gilt Issuance than We Had Expected Gross issuance planned for 2009/10 is £220 billion (after £146.5 billion in 2008/9), and looking at the DMO’s illustrative financing projections, the forecast doesn’t seem to come down much in 2010/11. The biggest miss versus our original projection is down to financial sector interventions. In addition to (effectively) the deficit, the gross issuance number is boosted by nearly £40 billion in extra cash required for the financial sector including for Northern Rock, £5.5 billion for Bradford and Bingley and £19 billion for RBS. Over 2009/10-2011/12, it now looks like anticipated issuance based on the Budget forecast and the DMO’s illustrative projections could be more than £600 billion. The Budget’s Impact on the Gilt Market Key points: • CGNCR and therefore gilt issuance was much higher than expected (although PSNB was closer to our expectation, at £175 billion). The difference is due largely to financial sector interventions. • The distribution of gilts along the curve is more in line with our expectations, with just 35% of issuance in long conventionals and index-linked. Shorts and mediums are equally weighted: we thought shorts would be a larger proportion. • The DMO has reduced its ‘execution risk’ (i.e., the risk of under-subscribed auctions) by introducing syndication and a post-auction option for successful bidders to buy stock at the auction average. • Gross issuance will remain very high for several years – partly thanks to larger redemptions – so steepening pressure on the yield curve (at least in 2s/10s) should persist. • Key supply/demand risks for the gilt market are 1) whether the BoE decides to extend its quantitative easing (QE) programme of purchasing gilts, and 2) news from the FSA regarding whether it will introduce its new liquidity regime for banks according to the schedule set out last December. Higher Issuance, Relatively Fewer Longs and Index-Linked CGNCR (and therefore gilt issuance) in 2009/10 will be some £49 billion higher than the central government net borrowing requirement due to: the cost of financial sector interventions totalling some £38 billion; £5.5 billion for ‘net lending to private sector and abroad’ (that’s similar to 2008/9); and a £5.1 billion ‘adjustment for interest on gilts’. Thus, 2009-10 gross issuance will weigh in at £220 billion, a record in all kinds of ways. Issuance will be concentrated in short- and medium-dated gilts, in a clear departure from recent years (though not from 2008-09, as it turned out). Indeed, the percentage of issuance in long conventional and index-linked gilts will be the lowest for a decade at least, at just 31%. The distribution of issuance between shorts and mediums will be less skewed towards shorts than we had expected, given the past year’s steepening of the yield curve. Presumably, this is because of the need to put a ceiling on the size of redemptions the DMO will have to re-finance in the next few years. Be that as it may, the weighting in shorts is less, we would argue, than the shape of the curve would otherwise warrant. There will still be plenty of short- and medium-dated gilts for sale, of course, with gross issuance up by £11 billion in shorts and £37 billion in mediums from 2008-09 levels. ‘Execution Risk’ Reduced The DMO has taken steps to reduce the ‘execution risk’ of undersubscribed auctions by introducing syndication and mini-tenders for a good proportion of long and index-linked issuance, and by introducing a post-auction option for successful bidders to buy stock at the auction average. Syndication, of course, obviates the risk that a particular sale will be undersubscribed, and increases the total size that can potentially be sold in a single transaction. Further, by issuing a total of £25 billion longs and index-linked via syndication, the DMO has made sure that the 2009-10 issuance of longs and index-linked will be nearly the same as last year, at £33 billion and £18 billion, respectively. By doing so, we think that the DMO has also reduced the aggregate ‘execution risk’ in these remaining auctions. While it’s true that the same volume of longs and index-linked bonds (£76 billion) has to be sold, be it by auction, mini-tender or syndication, we believe that using syndication for about a third of long and conventional issuance does reduce the total duration risk to the GEMMs. Thanks to the introduction of syndication, the outright long and index-linked duration risk they have to shoulder at auction (and mini-tender) is reduced from what it would otherwise have been – which may make failed auctions less likely. The introduction of the post-auction option is also an incentive for investors to participate at auctions. High Gross Issuance: Steepening Bias The government’s revised budget arithmetic for the coming few years has seen expectations for gross and net gilt issuance substantially increased. As we have demonstrated in the past, there is no historically robust relationship between the level of government borrowing and the level of yields, but there is a decent relationship between the level of government borrowing and the steepness of the yield curve. While the relationship is not very tight, the increase in government borrowing argues in favour of a steeper yield curve, at least between shorts and mediums. In the shorter term, however, the effects of the Bank of England’s QE buying make it difficult for this part of the yield curve to steepen. Key Supply/Demand Risks Two significant event risks may affect demand for gilts in the near future: whether the BoE chooses to extend its QE programme of purchasing gilts; and whether the FSA will introduce its new liquidity regime for banks, which, according to the schedule set out last December, is set to be fully in force by October. The FSA’s liquidity regime could generate scores of billions of pounds’ worth of demand for gilts from banks (see Regulatory Upheaval for Banks and Gilts, February 23, 2009). Given the timescales involved, we would expect to see an announcement soon.
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¿QuÉ Pasó? ¿QuÉ Pasa?
April 24, 2009
By Manoj Pradhan & Joachim Fels | London
Global quantitative easing (QE) is alive and kicking: Purchases of government securities and risky assets by the Fed, the BoJ and the BoE are slowly but surely delivering the double thrust of an expanding money supply as well as lower yields and tighter spreads. However, markets have not paved the way unquestioningly for these unconventional measures. Money supply growth in the US has eased somewhat since the start of the year even as the Fed has stepped up the size of its ‘active QE’ programme (see “QE2”, The Global Monetary Analyst, March 4, 2009 for the definition of active/passive). Further, 10-year Treasury yields have backed up to within 10bp of the 3% mark, up from the lows of nearly 2% at the end of last year and also up from the 2.5% level reached when plans to purchase Treasury securities were announced on March 18. Are these developments reason enough to doubt the success of QE? Or do they suggest that the Fed now has to do more to get QE back on track? The answer to both questions, in our view, is no. The majority of the active QE programmes by the Fed and other central banks are yet to be implemented, with further enhancements in the size and scope of these purchases still possible. The global, synchronised nature of these unconventional measures is also important because it brings into play the strong links that are present among international financial markets. QE2 has had a dual purpose for most central banks – to increase money supply and to directly lower the cost of borrowing for the private sector through directed purchases of government and risky securities (it is so called QE2 because we view it as the younger and stronger successor of the QE regime in Japan from 2001-06). Regardless of the objective, both money supply measures and cost of borrowing in the targeted sectors have generally shown favourable responses. Expansion in M1 bodes well for QE traction: Money supply in the US, Japan, UK and euro area (where the ECB has been expanding its balance sheet via passive QE since September 2008 along with the other major central banks) have all seen steady increases in base money and money supply M1 of late. We maintain that M1 is the best metric to gauge the traction that QE programmes will achieve to help revive growth, not in isolation but in conjunction with other monetary and fiscal measures. In the past, we have shown that M1 tends to lead recoveries whereas credit growth (particularly when a credit crisis is playing out) tends to lead the recession but lag the recovery (see “Credit Confusion”, The Global Monetary Analyst, February 4, 2009). Our own empirical work supports this analysis – we find that the real economy and credit both respond to changes in the money supply and that developments in the real economy tend to lead credit growth. Broader measures of money do not convey much information on spending or purchases of assets because these broad money measures include some form of savings such as time deposits and savings deposits. Reason to Worry in the US? M1 in the US, however, has warranted a closer look since the new year and has prompted some to question whether the most aggressive QE programme in monetary history is working. Dave Greenlaw, our Chief US Fixed Income Economist, attributes the easing in M1 growth to matters unrelated to QE. The weaknesses in the stock market and housing market have likely led to a weaker-than-usual build-up in demand deposits in the run-up to the end of the financial year on March 31, where most would be paying taxes on their capital gains. As a result, the seasonally adjusted data are likely showing a weaker number for M1. If this is indeed the case, we should see M1 growth start to rise again after the tax deadline as the fall-off in demand deposits will also be smaller than in a typical year. However, there is an even simpler reason to expect M1 to grow strongly in the near future – the sheer amount of assets that the Fed is yet to purchase. Since the inception of QE, M1 has grown by roughly US$200 billion. The Fed has purchased around US$500 billion of assets so far – which means that it has about US$1.25 trillion of asset purchases yet to go. Even if only a further US$200 billion of this were to find its way into M1 over the next three months, the year-on-year increase in M1 at that point would be 26% and M1 would stand at US$1.75 trillion compared with around US$1.35 trillion before the introduction of active QE. Global QE fanbase is growing: Active QE is generating some interest even in economies where policy rates are far away from ZIRP. The Reserve Bank of India (RBI) recently announced that it would buy US$16 billion of government bonds and prematurely buy back US$8.4 billion of its own bonds (see India – Flirting with QE, April 7, 2009), resulting in an unsterilised injection of liquidity that seems to be aimed at shoring up falling M1 growth. The purchases of government securities would also encourage bond yields to fall in line with the rate cuts that the RBI has continued to deliver, the latest taking policy rates to 4.75%. Et tu China? The Chinese policy of increasing bank lending at a rapid rate has also led to rapid growth in M1 as recipients of funds deposit some of them in demand deposits and set off the deposit multiplier. Such a policy of pushing up monetary aggregates without using policy rates (here by choice rather than because of the zero lower bound on policy rates – the policy rate is 5.31% and was cut in December) is akin to ‘QE by stealth’. Perhaps our view is QE-tinted but the increase in narrow money and credit in China actually trace what other QE-adopting central banks would dearly like to see. Elsewhere, base money and M1 have been growing rapidly in Sweden and Norway, where passive QE has been in place since September 2008, and in Switzerland and Israel, where active QE through the currency market and purchase of government bonds, respectively, has been underway for some time now. Finally, with policy rates brought down to 0.5%, the Swedish Riksbank mentioned that further measures may be introduced if it finds the need to deliver additional monetary stimulus. Spurred by the massive operations at the major central banks, QE is becoming a natural extension of rate cuts at many smaller central banks in this easing cycle. Yields and spreads are responding favourably: The second dimension of QE2 – the direct assault on the cost of borrowing – has been performing well as central banks make steady progress towards the targeted size of the active QE programmes. The Fed has thus far completed 15-30% of the purchases of MBS, Agency debt and Treasury securities that are part of its active QE programme. In mid-March, it more than doubled its MBS purchases from an initial US$500 billion to the current US$1.25 trillion, doubled purchases of Agency debt and introduced plans to purchase US$300 billion of Treasury securities. This massive increase in the size and scope of the active QE programme has acted and will likely continue to act as a deterrent to investors who may try to fight the Fed. To underscore the credibility of the Fed’s commitment to the cause, 10-year yields have flirted with but have not crossed 3%, despite the ongoing rally in equity markets, and mortgage spreads have continued to narrow. The BoJ and the BoE have also gone about the business of purchasing safe and risky assets according to their plans. Purchases of corporate bonds and commercial paper have recently been stepped up at the BoJ, with continued steady buying of government securities to the tune of JPY1.8 trillion per month. The BoE has purchased about half of the £75 billion of securities it seeks, with £38 billion coming in the form of gilts. Both the BoJ and the BoE are on track to use the rest of their considerable firepower to expand money supply and ease borrowing conditions. The ECB is expected to communicate its intentions on further non-standard measures to markets at its next meeting. Our ECB watcher Elga Bartsch expects the ECB to extend the term of lending and expand the range of collateral as measures to ease financial conditions – both tools of ‘passive QE’ – but to stop short of announcing outright purchases of government bonds. If the ECB were to embark on active QE, purchases of risky assets such as commercial paper and corporate bonds are more likely than government securities. The entry of the ECB into the world of active QE would be a huge step and would likely provide a strong tailwind to financial markets. For more details, see “QE or Not QE?” The Interest Rate Strategist, Elga Bartsch and Laurence Mutkin, March 20, 2009. Bottom line: Our survey of money supply measures, interest rate levels and spreads all suggest that active and passive QE is doing what it is supposed to do: increase money supply and improve financing conditions. Importantly, most central banks are not even halfway through with their announced active QE programmes, and the size of these programmes could easily be increased, if needed. Thus, we continue to expect global QE to be an important contributor to a bottoming of the global economy over the summer and to prevent temporary and ‘good’ deflation (deriving from declines in energy and food prices) from turning into lasting and ‘bad’ deflation.
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2009 Outlook Upgrade on Stronger-than-Expected Policy Responses
April 24, 2009
By Qing Wang, Denise Yam & Steven Zhang | Hong Kong
Less-Bad-than-Expected Developments in 1Q09… The Chinese economy posted 6.1%Y real GDP growth in 1Q09. While this is down from 6.8%Y in 4Q08, it is stronger than we expected, mainly reflecting a sharp sequential rebound in economic activity in March following the plunge in January-February. We estimate that the seasonally adjusted quarter-on-quarter growth rate reached around 1.5% in 1Q09, an acceleration from 0.4% in 4Q08. Both private investment and consumption have shown resilience, while export growth appears to be bottoming (for a detailed description of the developments in 1Q09, please see China Economics: ‘Worse’ in 1Q09, but Not as Bad as Expected, April 16, 2009). Of particular note, real estate investment has registered some tentative signs of recovery on the back of a significant pick-up in property sales in recent months, with real estate development investment expanding by 7.3%Y in March, after dipping to just 1% in January-February, though still much weaker than the 21% expansion last year. Resilience in domestic demand and narrowing declines in trade helped to stage a noticeable bounce-back in value-added industrial output to 8.3%Y in March, up from 3.8% in the first two months. However, power output fell 0.7%Y in March (-2.6% in 1Q09), seemingly contradicting the trend in overall output. We believe that this could suggest a more severe slowdown in the power-intensive sectors, such as steel and other metals, as high raw material prices last year encouraged speculative production and overstocking. …Reflect Stronger-than-Expected Policy Responses… We attribute the better-than-expected economic performance to the very aggressive policy response to the hard landing in 4Q08 that has served to lessen the depth of the cyclical trough. In particular, policy-driven monetary expansion drove money and loan growth to record highs in March, up 25.5%Y and 29.8%Y, respectively, with new loans made in 1Q09 totaling Rmb4.6 trillion, almost 3.5 times the amount in the year-ago period, or 93% of 2008’s total. While we do not think that such rapid credit expansion is sustainable throughout the year (see China Economics: Recent Rapid Bank Credit Expansion Not Sustainable, February 2, 2009), the heavily front-loaded policy response of ‘crisis-management’ style to support growth has helped to effectively shore up the confidence of private investors and households and reflate the asset markets, in our view. In particular, investments undertaken by the fiscal stimulus plan have already had a jump-start. In particular, the newly launched investment projects surged, primarily driven by investment in infrastructure areas (e.g., railways). …Warranting a 2009 Outlook Upgrade We upgrade our 2009 GDP growth rate forecast for China to 7.0% from 5.5%. While we had envisaged a V-shaped recovery for 2009 in our original forecasts, we now think that, in view of the less-bad-than-expected developments in 1Q09 and stronger-than-expected policy response, the recovery will be sooner and stronger, warranting an outlook upgrade. In particular, it appears that a rosy ‘goldilocks recovery scenario’, which we had previously thought of as a low probability event, is playing out. Specifically, we had envisaged that, under this ideal recovery scenario, the Chinese authorities’ policy responses would help to boost the real economy by reflating asset prices first. The goldilocks recovery scenario would therefore feature a series of positive catalysts, such as the following: “1) a technical rebound in growth as de-stocking runs its course and trade finance normalizes somewhat in 1Q09; 2) on the back of a policy-induced, liquidity-driven stock market rally (despite weakening fundamentals), the confidence of consumers and private investors is boosted despite job loss and slower sales/income growth, thus preventing too rapid a slowdown in consumption and private investment in late 1Q and 2Q09; 3) the effect of fiscal stimulus starts to show in a major pick-up in public investment growth in late 2Q or early 3Q09; and 4) the G3 economies bottom and stage a tepid recovery in 4Q09, improving external demand and further boosting confidence” (see “Mapping the Recovery in 2009-2010”, China Strategy and Economics: 2009 GDP Recovery Unlikely to Boost Profits or Equities, February 23, 2009). We expect seasonally adjusted quarter-on-quarter sequential growth in 2Q09 to accelerate strongly to 2.9% from 1.5% in 1Q09. However, the headline year-on-year growth rate will likely remain relatively low at 6.3% (versus 6.1%Y in 1Q09) and only start to accelerate significantly to 7.0%Y in 3Q09 and 8.6%Y in 4Q09, as the sequential quarter-on-quarter growth rates are envisaged to be maintained at around 2.0%. In revising the forecasts, we envisage that more resilient private consumption and investment help to offset weaker exports in 2009. We revise consumption growth to 7.5% from the previous 6.2%, as consumer confidence sustains and wage growth moderates but does not collapse (more discussion later). Incidentally, Morgan Stanley’s China Retail Sales Leading Indicator (RSLI) projects an uptick in nominal retail sales growth of 8.2% in September 2009 from 7.3%Y in August 2009, based on the latest released macro data (see Angela Moh’s China Retail: An Uptick in China Retail Sales Leading Indicator, April 20, 2009). We made a substantial upward revision of real estate investment growth from -12% to zero. Regular readers of our reports may recall that while we have long been positive on the outlook for China’s property sector, we also consider that investment in this sector is the biggest swing factor in determining China’s growth outlook (see China Economics: Can the Property Sector Be Counted on as the Engine of Growth? September 2, 2008). In view of the strong property sales – which we believe are sustainable – so far this year, we think that the recovery in property investment in 2009 will be faster than we originally expected. The Risks: Bull and Bear Cases We also revised our two alternative scenarios – bear and bull cases – to highlight both downside and upside risks to the 2009 outlook for the Chinese economy under our new baseline scenario. We think that the key risk to our new forecasts stems from the external demand outlook and its attendant impact on private investment in the manufacturing sector. The GDP growth rates under the bull and bear scenarios are 8.5% and 5.5%, respectively. We assign subjective probabilities of 75% to the base, 15% to the bear and 10% to the bull cases. Under the bull scenario, a faster and stronger recovery in G3 demand implies that China’s export growth turns positive sooner than expected (in 3Q09) and private investment in manufacturing sector registers positive growth. Moreover, fiscal and monetary stimuli are assumed to remain in place despite the earlier-than-expected recovery in external demand. Under the bear scenario, the economy double-dips after 2Q09. Much weaker exports more than offset fiscal stimulus efforts and hurt sentiment again. Export growth remains negative throughout the year, leading to a large outright decline in private investment in the manufacturing sector. Concerns about Inflation Unwarranted The rapid expansion of bank lending and money supply (M2) growth have caused some concern about the risk of inflation and, in connection with this, a potential abrupt policy tightening. However, we argue that these concerns are unwarranted in the next 12 months. First, the much weaker exports represent a negative demand shock that is deflationary. China’s past experiences suggest that a significant decline in export growth should have a meaningful disinflationary/deflationary impact on the economy. China has suffered two episodes of deflation in recent history: one during the Asian Financial Crisis and the other in the aftermath of the NASDAQ stock bubble burst. The deflation either coincided with or occurred in the immediate aftermath of a collapse in export growth. In view of the much weaker external demand this time around, the downward pressures on inflation will only be larger and more persistent, in our view. From the supply side, the bursting of the international commodity price bubble has caused the prices of raw materials (e.g., crude oil, iron ore, metals) imported by China to decline sharply, representing a powerful positive terms-of-trade shock. Moreover, there has been a strong supply response over time to high pork prices, which has been the key driver for China’s food price inflation since 2007. These positive supply shocks suggest that the supply of raw materials and food – the traditional bottlenecks in China – is unlikely to pose inflation risks in the foreseeable future. Profitless Growth? We have been arguing that while public sector-driven growth will help to achieve headline GDP growth and job creation targets and thus limit the extreme downside risk, it will not be able to deliver nearly as strong corporate earnings growth as when the same level of headline GDP growth is fueled by buoyant private sector spending. We believe that the public sector-driven growth will be a ‘job-rich’ but ‘profit-deficient’ macroeconomic environment, as suggested by the experiences in the past. The key question is when corporate earnings can be expected to recover. We think that the aggregate corporate earnings or operating surplus is a function of autonomous final demand, speed of supply-side adjustment and international commodity prices. These factors will likely point to a potential improvement in corporate earnings in 2H09 compared to 1H09, in our view. First, we expect both exports and real estate investment – the final demand items that are not related to fiscal spending – to start to recover in 2H09. Second, supply-adjustment measures featuring policy-driven production capacity retrenchment will likely be well underway by mid-year. Third, international commodity prices and thus cost pressures are expected to remain subdued, given that an early recovery in China, in the absence of a recovery in G3, is unlikely to drive up international commodity prices (see China Economics: The Supply-Side Adjustment, March 12, 2009). Policy Calls Despite the latest data for March indicating that the economy may have bottomed, and even shown signs of recovery and a surge in bank lending growth, we do not expect any meaningful shift in monetary policy stance in the near term. We expect the monetary policy stance to be kept sufficiently loose until an economic recovery is firmly underway, which we expect to materialize by mid-year (see China Economics: US Fed’s QE Points to More Monetary Easing in China, March 25, 2009). In view of the persistence of deflation, we expect one 27bp interest rate cut in 2Q09 and further RRR cuts if warranted by liquidity needs. However, we do expect rapid new loan creation to moderate in the coming months, as the authorities’ monetary policymaking shifts from a ‘crisis management’ mode to one of ‘conventional monetary easing’ over the course of the year. Total new loan creation could reach up to Rmb7 trillion for the year, in our view. We expect loan growth to moderate to 18-20%Y towards the latter part of the year, although the share of medium- and long-term loans in total new loan creation should increase as the investment projects under the stimulus plan are carried out. Meanwhile, upon realizing a better-than-expected performance in 1Q09, we believe that there is no need for additional fiscal policy stimulus in the near term. Maintaining the status quo in the fiscal and monetary policy stances should lead the economy further up its recovery path, in our view. 2010 and Beyond As soon as the economy shows signs of a firm recovery (likely by mid-2009), we expect that investors will start to focus on the sustainability of growth through 2010 and beyond. We keep our original forecast of 8% GDP growth in 2010 unchanged. We expect the headline GDP growth rate to peak in 1Q10 and start to moderate over the course of 2010 towards a more sustainable level of 7%Y by year-end. The deceleration in growth rates over the course of 2010 would reflect the recovery in exports and private investment being partly offset by a smaller fiscal policy stimulus. However, it goes without saying that there is considerable uncertainty about the outlook for 2010 for the global economy. First, as it stands now, our global economics team expects that both the US and Eurozone will start to deliver positive GDP growth by 4Q09 before embarking on a sustained recovery through 2010 (see Global Forecast Snapshots: The Global Economy in One Place, April 14, 2009). However, at the current juncture, it is still quite uncertain whether the G3 economies can successfully stage such a decent recovery. Second, in the event that the G3 economies were to fail to recover in 2010, this would require an even stronger fiscal policy response from China, if the objective were to deliver 7-8% growth per annum. For instance, we estimate that the fiscal deficit in 2009 would be about 3% of GDP. If the same size of fiscal stimulus were to be delivered in 2010, this would entail a fiscal deficit of about 6% of GDP, in our view. At some point, the authorities would have to weigh the benefits of propping up growth through public spending against the attendant fiscal and efficiency costs. Assuming no additional policy stimulus of considerable size despite the absence of a G3 recovery, we do not believe that the policy-driven recovery in 2009 can be sustained in 2010.
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