Policy support to be stepped up further

April's economic data may show signs of stabilization due to continued policy support and evaporating Chinese New Year holiday distortions. Property sales are likely to show their first year-on-year growth in 18 months, export growth is expected to be up by 5 percent from a year earlier and industrial production may have grown more than 6 percent year-on-year.

Despite these tentative signs, real activity has remained generally weak, with faltering PMI new orders and rapidly declining producer prices pointing to still frail domestic demand and worsening corporate balance sheets. Although the sharp slide in March's activity has been arrested, further policy support is needed if growth is to get close to this year's target of 7 percent.

China's authorities are becoming more concerned about the ongoing economic downturn and policy tones are becoming more accommodative. The Politburo meeting on April 30 underscored challenges facing the economy and called for more "forceful" support, including by boosting investment and encouraging healthier development in the property sector.

The meeting statement acknowledged that the economy faces "heavy downside pressures", which "warrant close attention and a forceful policy response". The meeting pledged to "step up targeted measures" to combat downward pressures and ensure a good balance between growth, reform, structural change and risk prevention objectives. Fiscal policy needs to "increase public spending and tax and fees relief" and monetary policy has to "appropriate" while "improving the transmission to the real economy".

We noted a subtle change in tones regarding investment, which the Politburo considered key in supporting growth and called for measures to ensure adequate financing and property, for which a long-term mechanism for healthy development is to be established. We think this suggests the further investment support and property policy easing may be in the pipeline.

Over the next two months, we expect the government to:

a) Speed up key infrastructure projects in railways and subways, water works, environment protection, energy and utilities, backed with faster fiscal disbursements and enhanced lending support from policy banks and commercial banks, including through the expansion of PPP programs.

b) Increase central government liquidity support through PSL and other similar instruments, deliver another (symmetric) benchmark interest rate cut, further expand the renminbi loan quota to help offset the slower expansion in shadow credit, and ease other credit restrictions.

In addition, we think the PBOC may cut RRR by at least another 100 bps during the rest of the year to help offset the larger-than-expected capital outflows as well as lower market interest rates and facilitate the local government debt swap.

On the latter, we believe local government debt swap should take place directly between local governments and bank creditors, which should not require the central bank providing additional liquidity before and withdrawing after the swap, the government may still decide to increase liquidity provision in the process to ensure a smooth operation given the complexity of the swaps.

Our current forecasts have already assumed increased policy support from the start of the year, which should help growth momentum to pick up in Q2 to around 7 percent quarter-on-quarter and 7.1 percent year-on-year. However, given the ongoing structural property downturn and lackluster global demand, and the transitory nature of policy support, we still expect growth to slow again later in the year. Therefore, we maintain our real GDP growth forecast of 6.8 percent for 2015 and 6.5 percent for 2016.

This article is co-authored with three other UBS economists Harrison Hu, Donna Kwok, and Ning Zhang. The views do not necessarily reflect those of China Daily.