Real estate concern

Identifying real estate as the biggest swing factor among all scenarios, Wang said that weakening external demand was not the primary reason for China's sharp economic slowdown as deceleration in exports had been gradual and taking place since mid-2007.

It was the macroeconomic tightening policy package launched in late 2007 to avert overheating that has hit the property sector hard. As a consequence, real estate investment has slowed substantially, diminishing demand for key construction materials, such as steel, cement, and aluminum, and housing-related consumer durable goods, he noted.

Wang envisaged a significant decline of six percent (in real terms) in real estate investment from the private sector next year, contending that the chance of a massive industrial collapse on a nationwide scale was small.

To activate the property market, Chinese government has rolled back austere measures previously taken to prevent the economy from overheating, reduced taxes and cut interests.

"There has been a welcome correction in property prices, we expect housing affordability to increase, sentiment to improve, and property sales to stabilize by mid-year 2009", said the report. "Further property-sector-boosting policy measures will likely be implemented in the coming months."

Deflation risk

In this report, Morgan Stanley Asia also revised its Consumer Price Index forecast for 2009 from 1.5 percent down to -0.8 percent, pointing to a "high deflation risk".

From the supply side, the bursting of the international commodity price bubble since October has spawned a sharp decline in the prices of raw materials imported by China. Moreover, weakening exports that are expected to continue amid a synchronized recession in G3 economies also exacerbated the problem of production overcapacity, limiting Chinese producers' pricing power, it said.

"Deflation is not always a bad thing. The challenge is to prevent deflationary expectations from getting entrenched. This necessitates a strong, preemptive monetary policy response," Wang said.

Morgan Stanley therefore expected China's central bank to cut benchmark interest rates aggressively by an additional 162 basis points over the course of 2009. And to ease deflationary expectations, the cuts will most probably be done in the first half.

Although China's economy would steer clear of the extreme downside risk of an outright hard landing after current public-sector-driven growth helped achieve the headline GDP growth and job creation targets, the stimulus would not deliver nearly as strong corporate earnings growth as when the same level of headline GDP growth was fueled by buoyant private-sector spending.

"China's macro-economic environment will be relatively job-rich but profit-deficient in which bonds tend to be favored over equities," Wang said.

(Xinhua News Agency December 11, 2008)