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Morgan Stanley's Feeling Pretty Good About the Chinese Economy - For Now

Slowdown on hold.

China's economy has done such a good job of defying bearish prognoses that it warrants an upgrade, according to Morgan Stanley analysts who last week adjusted their expectations for the country's growth.

While a few economists have been souring on China's growth prospects, Morgan Stanley's Robin Xing and Jenny Zheng in a report released last week, raise their GDP forecasts to 6.7 percent from 6.4 percent for this year, and to 6.4 percent from 6.2 percent for 2017.

In doing so they part ways with some other recent assessments of the country's growth potential: analysts at Deutsche Bank AG recently downgraded their Chinese growth expectations for the second time in three months, while the only change the International Monetary Fund made to its China forecasts when it revisited them last week was to turn more pessimistic on the pace of growth in 2018. Both Deutsche Bank and the IMF's forecasts for 2016 rank more conservatively than Morgan Stanley. 

Still, consensus is shifting in Morgan Stanley's favor: at the end of September, when Bloomberg surveyed 58 economists on the subject, their average expectation of 2016's expansion improved slightly, to 6.6 percent.

"Our numbers are slightly above consensus, mainly reflecting cyclical momentum thanks to strong fiscal support, and better-than-expected external demand," the Morgan Stanley analysts wrote in their report.

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In 2015 China registered its slowest growth-rate in a quarter of a century. So-called "4D challenges" (debt, destocking, disinflation and demographics) and the government's sluggish adjustment toward structural reforms mean that the country's growth is on a decelerating trajectory, they said.

Still, policy can influence mini-cycles along that path, and the current one has benefited over the last year from factors including generous government spending, added the analysts.

Stronger investment activity and car sales also helped the mid-cycle upturn last longer than Morgan Stanley had previously expected, while external demand turned out stronger than anticipated as the fallout from Britain's vote to leave the European Union remains relatively subdued.

The analysts reckon that auto sales will remain strong before a tax exemption expires at the end of the year, while the property rally and strong demand for Chinese exports are also forecast to continue, meaning they expect the economy to have expanded by 6.7 percent in the third quarter and 6.6 percent in the fourth. 

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The economy's expansion will slow from next year, the analysts predict.

"The quarterly growth trajectory has likely peaked in [the third quarter of 2016], and should gradually moderate in 2017, considering a likely slowdown in car sales and property market activity on reduced policy support," the report said.

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"The structural headwinds of high debt and weak productivity will weigh down the growth trajectory beyond the near term," said the analysts.

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