Cny China V

| On the Ground |

http://research.standardchartered.com Analysts Li Wei, +86 21 6168 5017 Standard Chartered Bank (China) Limited Economist [email protected]

Stephen Green, +86 21 6168 5018 Standard Chartered Bank (China) Limited Head of Research, China [email protected]

Judy H Zhu, +86 21 6168 5016 Standard Chartered Bank (China) Limited Commodity Analyst [email protected]

China – The end of the ‘V’ 08:00 GMT 11 August 2009

July data suggests that the recovery continues but is losing some momentum, as expected Official policy stance remains unchanged, though fine-tuning, especially of monetary policy, is expected in the next few months Some weakness in some commodity imports appearing

Today’s avalanche of China data suggests that the economic recovery is solid, but that the momentum ebbed in July. What was a V-shaped recovery now seems to be experiencing a little gravitational pull. A number of indicators – industrial and electricity production as well as fixed asset investment – showed either flat or slightly weaker year-on-year growth in July. New bank loans came in at only CNY 355.9bn (USD 52bn), well below June’s CNY 1.53trn; as we explain below, this lending went heavily to households rather than corporates (see Table 1). The slightly weaker-than-expected data means an even smaller chance of an imminent change in macro policy and lends weight to those who argue that it is too early to tighten. Having seen the data early, Premier Wen Jiabao restated at the weekend that the goal was to maintain a proactive fiscal policy and a moderately loose monetary policy. Table 1: China’s July data Growth, y/y

July-09

June-09

H1-09

2008 average

CPI

-1.8%

-1.7%

-1.1%

5.9%

PPI

-8.2%

-7.8%

-5.9%

6.9%

M2*

28.42%

28.46%

21.14%

16.67%

FAI, YTD

32.9%

35.3%

35.3%

26.1%

Industrial value added

10.8%

10.7%

7.0%

12.9%

Retail sales

15.2%

15.0%

15%

21.6%

Exports

-23.0%

-21.4%

-21.7%

17.2%

Imports

-14.9%

-13.2%

-25.4%

18.5%

Trade surplus

USD 10.6bn

USD 8.2bn

USD 96.9bn

USD 295.8bn

* M2 H1-09 is average of month-end data for the six months of H1-09 Sources: NBS, Customs, PBoC, CEIC

Inflation expectations are not an immediate threat Prices are stable overall, but are of course a lagging indicator of demand. The consumer price index (CPI) fell by 1.8% y/y in July, compared with a fall of 1.7% y/y in June. The producer price index (PPI) fell by 8.2% y/y, versus a fall of 7.8% y/y prior, as shown in Chart 1. On a month-on-month (m/m) seasonally adjusted (sa) basis, however, prices have stopped falling since March. Since then, prices have risen a bit, and in July both were basically flat, as we show in Chart 2.

Ref: GR_20Jul09

Important disclosures can be found in the Disclosures Appendix.

On the Ground | 11 August 2009

Inflationary expectations have risen, though. While the recent PBoC report toed the official line, we know that the central bank is much more concerned than other government agencies about inflation (see OTG, 5 August 2009, ‘Monetary policy update’). We forecast that CPI will return to positive y/y growth around November. This will likely be one of the triggers of a shift in the overall monetary policy stance. This shift will likely involve hikes in the required reserve ratio (RRR), which we expect in Q4, to be followed by interest rate hikes in H1-2010, and even possibly loan quotas. The RRR hike is significant, as the PBoC needs the State Council to sign off before it can go ahead. However, today’s data does not bring that day closer.

Chart 1: Prices falling year-on-year….

Chart 2: . . .but stable m/m

12

3

9

2

6

1

3

0

0

CPI, y/y %

PPI, y/y %

Sources: CEIC, SCB Global Research

CPI, m/m sa %

Jan-09

Jan-07

Jan-05

Jan-03

Jan-09

Jan-07

-3

Jan-05

-9

Jan-03

-2

Jan-01

-6

Jan-01

-1

-3

PPI, m/m sa %

Sources: CEIC, SCB Global Research

All eyes on infrastructure projects and real estate Fixed asset investment (FAI) continued to grow in July – we calculate a 29.7% y/y increase, as shown in Chart 3. (In real terms, FAI rose even faster, by around 34% y/y.) Given the large volume of planned investment, the accommodative policy stance, and the gradual recovery in private investment, we expect FAI to remain strong. However, it appears as though the momentum has ebbed here, too. The nominal growth rate of 29.7% y/y in July was a deceleration from the monthly average of 35% y/y in Q2. (This data, though, is problematic, so we do not have huge confidence in it alone.) However, corroboration is provided by project data. There were only 29,600 new project starts in July, compared to a monthly average of 41,060 in Q2-2009. In fact, July saw the first negative month-on-month growth in new project starts since October 2008 (adjusting for Chinese New Year). This is further evidence that the stimulus package was heavily frontloaded, meaning that investment growth may well plateau around these levels for a while.

Ref: GR_20Jul09 2

On the Ground | 11 August 2009

Chart 3: Continuous strong FAI growth

Chart 4: Are house prices too high now?

70

50

150

40

100

30

50

30

20

0

20

10

-50

0

-100

60

FAI growth, y/y %, 3mma

Sources: CEIC, SCB Global Research

Jan-09

Jan-09

Jan-07

Jan-05

Jan-03

Jan-01

Jan-99

Jan-97

0

Jan-08

10

Jan-07

40

Jan-06

50

Housing investment, y/y %, 3mma Housing sales, y/y %, 3mma (RHS) Sources: CEIC, SCB Global Research

This view is supported by the still-muted recovery in real estate investment. Real estate FAI only rose by 12.7% y/y in July, lower than June’s 14.6% growth (as shown in Chart 4), and still well below the 30% rates we witnessed over 2006-07. Housing sales, measured by floor space sold, grew by 69.6% y/y, up from June’s 54%. However, sales volume fell by 20.3% m/m in July, following growth of 35.3% in June. In Shanghai, many developers seem to be keen to hold on to apartments, waiting for further price rises before they release them. They are also probably not keen to start a massive wave of new projects until they feel surer about the medium-term future. New home prices rose by 1.1% m/m in July, according to official numbers, up 0.3ppt from June (though these numbers look very low to us – in Shanghai many apartment blocks are 30%+ up since January). There is some worry, both in the market and from officials, that the rises in home prices may have started to weigh on demand, especially among first-time buyers.

Industrial production growth flattened despite a stronger PMI Industrial value added (IVA) grew by 10.8% y/y in July, following a 10.7% rise in June (see Chart 5). While strong, this was below market consensus and suggests some deceleration in production momentum. The recovery in electricity production also weakened a bit, with growth slowing to 4.8% y/y from 5.6% y/y in June (though electricity production was up 18% m/m). Demand from stimulus-related infrastructure projects and the end of the de-stocking cycle have been behind the improvements seen here since Q2-2009. According to the Purchasing Managers’ Index (PMI), manufacturing new orders are still growing month-on-month, as shown in Chart 6. Inventories of finished goods fell by 2.2% y/y in July, suggesting that firms will be increasingly willing to build inventories of finished goods in the next few months (see OTG, 3 August 2009, ‘Through the inventory cycle’).

Ref: GR_20Jul09 3

On the Ground | 11 August 2009

Chart 6: PMI suggests an end of destocking

5 0

15

-5 -10

10

-15 -20

5

-25

Jan-07

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

-30

Jan-07

0

Jul-09

20

Jan-09

10

Jul-08

20 15 10 5 0 -5 -10 -15 -20 -25 -30

15

Jan-08

25

Jul-07

Chart 5: Industrial production flattens

New orders

IVA, y/y %

Purchases

PMI production, y/y %

Finished-goods inventories Sources: CEIC, SCB Global Research

Sources: CEIC, SCB Global Research

Retail sales stabilise on recovering confidence Retail sales rose by 15.2% y/y in July. In real terms, as shown in Chart 7, growth seems to have plateaued at around 17% y/y. According to eziData, consumer confidence continued to recover in June, as we show in Chart 8. Car sales continue to motor along. Chart 7: Sales stablise

Chart 8: Recovering consumer confidence

Jan-09

Jan-07

Jan-05

Jan-03

Jan-01

0

Nominal retail sales, y/y %, 3mma Real retail sales, y/y %, 3mma Sources: CEIC, SCB Global Research

Apr-09

6

Oct-08

12

Apr-08

18

Oct-07

105 103 101 99 97 95 93 91 89 87 85

Apr-07

24

eziData China Consumer Confidence Index (CCCI) Baseline survey, April 2007 = 100

Sources: CEIC, SCB Global Research

Far fewer new loans to the corporate sector CNY 355.9bn (USD 52bn) of new loans were extended in July, a considerable slowdown compared with CNY 1.53trn (USD 225bn) in June, as we show in Chart 9. Digging into these numbers shows an even sharper slowdown in lending to the corporate sector. CNY 236.5bn of the net increase went to households, who were busy buying homes with mortgages, while only CNY 119bn went to corporates (CNY 198bn worth of bills were repaid in July, as were CNY 58bn in short-term loans, while CNY 350.9bn worth of medium- and

Ref: GR_20Jul09 4

On the Ground | 11 August 2009

long-term loans were extended). Net extension of credit to the corporate sector in July was thus the smallest since November 2007, according to our numbers. After the blowout in June (when CNY 1.228trn of net loans were extended to corporates), a sharp slowdown was always going to happen, but this may still unnerve the market and is another signal that the momentum has dissipated. There is still no shortage of money supply growth, though – broad money supply (M2) rose by 28.42% y/y, as we show in Chart 10.

Chart 9: Exploding new loan extension

2,000

Chart 10: Explosive money supply growth

40

1,500

30

1,000 20

500 0

10

Sources: CEIC, SCB Global Research

M2, y/y %

Jan-09

Jan-07

Jan-05

Jan-03

Medium- and long-term, CNY bn Short-term and bill finance, CNY bn

0

Jan-01

Jan-09

Jan-08

Jan-07

Jan-06

Jan-05

-500

CNY loan, y/y %

Sources: CEIC, SCB Global Research

Based on our understanding, the PBoC will be happy to maintain new loan growth at CNY 400-500bn (USD 59-73bn) per month for the remainder of the year – CNY 2.5trn (USD 366bn) for all of H2-2009, or CNY 10trn (USD 1.5trn) for the whole of 2009. The July data will calm some nerves. Anecdotal news suggests that demand for loans is still strong, so all eyes will be on the August numbers to see if July was just post-June exhaustion or if it really did mark a change.

Imports up Exports fell by 23% y/y in July, and imports fell by 14.99% y/y – both a little weaker than June in y/y terms. We show the three-month moving averages in Chart 11. In month-on-month terms, some positive momentum continues – exports are rising 5% m/m in nominal terms on a 3mma basis, while imports are rising 7% on the same basis. We do not have volume data for July yet, but looking at June, we note an important shift on the import side. In real (volume) terms, imports grew by 3.7% y/y in June, while exports continued to fall, but the decline slowed to 14% y/y. (Chart 12 shows these numbers on a 3mma basis, which disguises the recent strength a bit but also removes some of the volatility.) We suspect that this trend continued in July – another sign that domestic demand has recovered – but that there was no further acceleration in July. The trade surplus of USD 10.6bn in July was bigger than expected, but not by much.

Ref: GR_20Jul09 5

On the Ground | 11 August 2009

30

20

20

10

10

-30

-40

-40

Jan-09

-20

-30

Jan-08

-20

Jan-07

0 -10

Jan-06

0 -10

Export, y/y %, 3mma

Export, y/y %, 3mma

Import, y/y %, 3mma

Import, y/y %, 3mma

Sources: CEIC, SCB Global Research

Jan-09

40

30

Jan-08

40

Jan-07

Chart 12: Imports are recovering (real)

Jan-06

Chart 11: Imports are recovering (nominal)

Sources: CEIC, SCB Global Research

Less arbitrage buying of commodities China has reduced speculative imports of some commodities, mainly copper and aluminium. In some other commodities, such as crude oil and iron ore, imports have increased alongside a recovery in demand and anticipation of further price hikes. Here, we discuss copper and iron ore. As Chart 13 shows, China’s imports of copper and copper products dropped from a record high in June to 406.6 thousand tonnes (kt) in July. We estimate that of the July imports, around 325kt was refined copper, down 14% m/m. This is the first time that imports have fallen m/m in seven months, although the numbers are still much higher than a year ago. The difference between London and Shanghai prices has meant that imports have been loss-making since early June. With few arbitrage opportunities in July, we expect China’s copper imports to fall further in August. China’s iron ore imports in July continued to reflect a mixture of real demand and speculation. They hit a new record high of 58.08mn tonnes, up 47% y/y and 5% m/m, as Chart 14 shows. Imports in the first seven months of 2009 rose by 32% y/y to 355.4mn tonnes. While record-high crude steel production has encouraged these imports, trading houses continue to import because they anticipate even higher steel production and higher prices in the coming months. Meanwhile, these traders continue to have access to easy credit from local banks. But we also note that some traders have already started to take a more cautious view of imports because of higher ore prices and some weakness in domestic steel prices. According to ‘Steel Index’, an industry publication, 62% iron-content iron ore fines delivered to China hit USD 104.1 per dry tonne yesterday, the highest level since the index began on 21 November 2008. An additional risk is that banks may tighten credit lines, but so far we have not heard of any instances of this.

Ref: GR_20Jul09 6

On the Ground | 11 August 2009

Chart 13: Copper imports Thousand tonnes

Chart 14: Iron ore imports USD/tonne

500

70 60

400

50 300

40

200

30 20

100

10

Copper and copper products 2007-2008 monthly average Sources: Chinese customs, SCB Global Research

Iron ore

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

Jan-07

Jul-09

Jan-09

Jul-08

Jan-08

Jul-07

0

Jan-07

0

2007-2008 monthly average

Sources: Chinese customs, SCB Global Research

Ref: GR_20Jul09 7

On the Ground | 11 August 2009

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Ref: GR_20Jul09 8

On the Ground | 11 August 2009

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Ref: GR_20Jul09 9