EM including China

The pickup in global growth momentum now underway is being tempered by a deceleration in China. China's October activity indicators out this week were mixed but generally consistent with our expectations for a moderate 7.4% annualized gain in real GDP this quarter. Exports were stronger than expected as was fixed asset investment, while retail sales growth held steady. However, industrial production increased just 0.5% mom, the same as the average for the previous two months, hinting at some drag from the inventory cycle. With excess manufacturing capacity, lower oil and other commoditiy prices, and only a moderate GDP expansion anticipated, we forecast inflation to ease to 1.5% yoy, or below, in coming quarters. Although this backdrop creates flexibility for easier monetary policy if it is needed, we expect two RRR cuts of 50bps each in 2015 intended mostly to maintain stable growth in the money supply amid a declining pace of FX reserbe accumulation. Still, the probability of a cut in policy rates is rising. Over the last six months, the PBOC has used liquidity operations to try to bring down bank lending rates, but the efficacy of this approach is limited, and if lending rates do not decline appreciably in 1Q15, the chances of a rate cut would rise substantially.

Inflation also is sliding across the remainder of EM Asia, fueling expectations for rate cuts more broadly. In India, inflation fell below 6% yoy in October, the lowest since the new CPI index was introduced three years ago. Nonetheless, we expect the RBI to remain on hold. The reputational risk of missing the 6% inflation target by January 2016 would be damaging, and the RBI will need more data to be convinced that food disinflation is structural and that core is not reaccelerating.
The chances of a rate cut in Korea have increased as well. Last week the BOK kept its policy rate on hold after easing 25bp in October. However, the central bank's statement was dovish, based on concerns over near-term growth and a potential loss of competitiveness from the weaker yen. Nonetheless, we are maintaining our forecase for a stable 2% policy rate. Growth is expected to pick up and the rise in the trade-weighted KRW has been much more muted that the move against the JPY. Moreover, the BOK is more likely to respond to additional yen weakness with FX intervention than a rate cut.