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SEB’s China Tracker: A blip in growth?

SEB’s China Tracker: A blip in growth?

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Published by SEB Group
Chinese growth will hit a soft patch from over-extended exports but will reaccelerate into the fourth quarter to hit our 8.1 per cent growth forecast for this year, writes Sean Yokota, SEB’s head of Asia Strategy, in a new report. Construction activity and accommodative monetary stance will put a floor on growth. The Chinese currency will continue its gradual appreciation from structural and cyclical factors and SEB’s economists still see USDCNY hitting 6.10 by year end.
Chinese growth will hit a soft patch from over-extended exports but will reaccelerate into the fourth quarter to hit our 8.1 per cent growth forecast for this year, writes Sean Yokota, SEB’s head of Asia Strategy, in a new report. Construction activity and accommodative monetary stance will put a floor on growth. The Chinese currency will continue its gradual appreciation from structural and cyclical factors and SEB’s economists still see USDCNY hitting 6.10 by year end.

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Published by: SEB Group on Apr 25, 2013
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You can also find our research materials at our website:www.mb.seb.se. This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinionscontained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any directorconsequential loss resulting from reliance on this document. Changes may be made to opinions or information contained herein without notice.
A blip in growth or more slowdown to come?
THURSDAY
25 APRIL 2013
EDITOR
Head of Asia Strategy
sean.yokota@seb.se+ 65 6505 0583
Welcome to our first publication of the “SEB China Tracker”- one stop shop on what’shappening in China macro and markets and what you need to watch going forward.
 The publication is split into 2 sections – 1) thematic focus piece and 2) macroeconomic andmarket charts and comments, which we think as the most important for China watchers.
Theme
- In this first edition, we will provide our general economic and market outlook sincethe two most frequently asked question over the last month are a) will the economy continueto slow after the weak Q1 GDP and b) why is the currency strengthening and will thatcontinue with a weaker growth? Our conclusion is that growth will hit a soft patch from over-extended exports but will reaccelerate into 4Q to hit our 8.1% growth forecast for this year.Construction activity and accommodative monetary stance will put a floor on growth. Thecurrency will continue its gradual appreciation from structural and cyclical factors and we stillsee USDCNY hitting 6.10 by year end.
Macroeconomic and market charts
– what stands out the most this month is the rapidrebound in hot money inflows (Chart 8) that supports a stronger CNY after 10 months ofstraight outflow. We think the rebound in the housing prices are keeping flows at home. Forpeople with access, going long CNY onshore is the mot favorable of the 3 separate CNYmarkets (Chart 12).
Tidbit
– One reason why we aren’t extrapolating the recent PMI weakness into somethingbigger is that key exporting cities like Dongguan, a hub for manufacturing in GuangdongProvince in Southern China is reporting good growth. Q1 real GDP growth was 8.6% yoy,compared to the 7.7% growth nationally. Dongguan’s authorities have raised 2013 GDPforecast to 10% from 7%.
 
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China Tracker
Theme – A blip in growth or more slowdown to come?
The two most frequently asked question over the last month are a) will the economy continue to slow after the weakQ1 GDP and b) why is the currency strengthening and will that continue with a weaker growth? Our conclusion is thatgrowth will hit a soft patch from over-extended exports but will reaccelerate into 4Q to hit our 8.1% growth forecastfor this year. The currency will continue its gradual appreciation from structural and cyclical factors. Below is why wethink so.
The Framework
Before we move forward, here is a brief background on the framework on how we analyze the Chinese economy. Wefocus on three main drivers 1) external demand 2) internal or domestic demand and 3) policy, mostly monetary, whichaccelerates or decelerates domestic demand. We focus on these three for the following reasons. First, China remainsthe manufacturing center of the world and external demand (exports) creates big cyclical swings. Exports generateincome for businesses and households and they influence domestic demand by spending that income on investmentand consumption. Second, China has domestic or internal demand and here we focus on investment rather thanconsumption since as many of you know, China’s investment is much bigger than consumption (almost 50% of GDPcompared to 35%). In addition, investment swings are more volatile than consumption and is the main driver ofcyclicality since consumption includes more “necessities” and cannot be cut drastically in economic downturns.Third, we classify monetary policy as the third main driver since in a world of low external demand, many economies,including China are relying on credit growth or leverage to generate higher growth. Furthermore, in China, much ofthe investment growth is supported by borrowing and change in monetary policy alters investment growthsubstantially. Now, many other factors impact the Chinese economy but we see these three as the biggest drivers andthe others would be sub-drivers that fit within them.
So how are these drivers looking?
The biggest change we see is weaker short term export outlook. Our US economist, Mattias Bruér sees slowdown inQ2 and Q3 this year, led by large inventory accumulation in Q1 (pulls growth forward) and fiscal tightening fromsequestration (see
Economic Insights, US economy 8 Apr 2013
). We are already seeing some signs of this from weakerUS ISM data and softening in China PMI. In addition, China’s exports are already at elevated levels, growing at almost20% yoy, which are as strong as pre-Lehman crisis levels in 2008 (Chart 1). This is difficult to sustain with lingeringEuropean risks and US going through a soft patch. Japan is turning around and can generate some demand but asChart 2 shows, it is a much smaller export market compared to US and Europe. Exports will likely level out or slowdown over the next quarter or two before we see it accelerate towards year end. We do not see a major slowdownsince our SEB China Financial Survey tells us that on the ground CEOs and CFOs in mainland are becoming moreoptimistic about the business climate for the coming six months (
China Financial Index, Rebound in China Confidence,5 Mar 2013
). Our index has jumped to 60.8 in March from 56.1 in September and profit expectations and fixed assetinvestment plans have substantially improved.On domestic demand, we focus on construction activity as the main driver of investment. The SEB ChinaConstruction Indicator continues to be strong (Chart 3). The question is more on the outlook since authorities haveintroduced new measures to control rising house prices in March. We think the measures will slow the pace ofacceleration in construction activity and stabilize around 20% yoy compared to the 40% yoy growth we saw in 2009.We do not envision a collapse in construction activity from the tightening measures. As you can see from Chart 4, theproperty price acceleration is concentrated in first tier cities (e.g. Beijing, Shanghai, Shenzhen) and the most of thecountry, which are in third tier cities and below are not experiencing similar price increases. The measures aretargeted at decreasing speculation and activity in first tier cities and the impact on the overall construction activityand economy will be muted in our view.Thirdly, monetary policy still remains accommodative. Real rates are barely positive at 0.9% (Chart 5, 1 year depositrates are 3% minus March CPI of 2.1%). In addition, as our regular readers know, we have been talking about growthin non-bank lending acting as another form of monetary stimulus (
 Asia Strategy Comment, China Trip Notes, 12 Dec 2012
) and it continues to accelerate (Chart 6). Recently, the authorities passed measures to control wealthmanagement products that may slowdown the pace of non-bank lending growth. However, we think non-banklending will continue to grow until we see two key changes, which we have yet to see. One, we’re looking for multipledefaults on domestic corporate bonds or trust/wealth management products that will teach investors that thesehigher yielding assets come with higher risk and dampen demand. So far when these products miss payments,typically a government, bank, asset manager or a company has come to the rescue. Until investors are taughtlessons, we think money will continue to pour into this area. Two, we need to see the central bank hike deposit rates.
 
 3
 
China Tracker
While deposit rates are low, households and corporates will continue to look for alternate means to store theirsavings, whether it be in housing, trust products or corporate bonds. If the authorities want to seriously curtail growthin non-bank lending, they will hike deposit rates continuously and we don’t see that risk emerging until Q4 when wethink a hiking cycle will start. In the meantime, we think monetary policy will be accommodative and continue tosupport China’s growth.To summarize our growth outlook, we think the economy will remain around current levels and balanced as exportshit a soft patch and become head winds, while construction and loose monetary stance keeps the economy anchoredaround 8%.
Impact on Markets
So how will this macro outlook impact markets and especially the path of CNY? For CNY our view hasn’t changed andwe still expect gradual appreciation for USDCNY to hit 6.10 by year end. As long as China runs a current accountsurplus, we think the authorities will stick to the structural, strategic policy to gradually strengthen CNY to encourageexporters to move up the value chain. In addition, the self induced slowdown in domestic activity in 2012 (back toChart 3) where the construction activity slowed to similar degree as the Lehman crisis, gives us more confidence thatthe government is serious about restructuring. The recent move lower in USDCNY fixing has shown that China iswilling to appreciate CNY despite the weakness in the Japanese Yen. Furthermore, flow also supports a stronger CNY.Before April, CNY hadn’t moved for five months since the inflows created by the current account surplus were offsetby equal amount of hot money outflow and kept the currency stable as you can see from Chart 8 below. China’s FXreserves also did not increase during this time. However, starting in March, the hot money flow has reversed toinflows and creates pressures for CNY to appreciate. We think stabilization in domestic house prices also encouragemore inflow (or prevent outflow) as holding CNY denominated houses again becomes a profitable form of saving andinvestment. With loose monetary policy, house prices will be supported, encourage hot money inflow and pressureCNY to continue appreciating.For interest rates, we still expect interest rates to start rising this year towards Q4. We see inflation gradually risingtowards year end from loose monetary policy and rising non-bank lending. Salaries are rising faster than the 2.1% CPIrate where over 70% of respondents from our China Financial Index survey expect salaries to increase by 8-9%.Return of hot money inflow will also add to inflationary pressures. We don’t see an immediate need for interest ratehikes as the soft patch in exports over the summer will slow the pace in inflation but this environment of loosemonetary policy and steady growth will lead to a beginning of a hiking cycle by year end.Lastly, equity markets have a period of 4-5 months to perform well. We are in steady growth and low inflationaryenvironment short term, which is favorable for equity market performance. Positioning and expectations are lowfrom poor performance, especially in relative to global equity markets that have performed well over the last 6months (Chart 16). China equity has also been hit by the new property tightening measures but as mentioned abovewe think the impact will be limited and allow for a recovery. But, going into Q4, we do see inflationary pressurespicking up and introduction of monetary tightening risk will weigh on market’s performance.

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