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Friday, September 11, 2009

China's Economy Continues To Grow, But All The Old Doubts Remain

China’s economy showed new signs this week that it continues to maintain momentum with the announcement that investment, industrial output and credit all expanded more rapidly in August.

Output and investment increases both came in ahead of analysts’ forecasts and came on the back of a string of July data that had suggested the recovery might be weakening. The one notable exception was, however, on the trade front, where the decline in exports and imports compared to August 2008 was sharper than expected.

China’s economy has been rebouning from the weakest growth in more than a decade on the basis of a $585 billion stimulus package which has produced a sharp surge in new loans surging and driven up manufacturing output and property sales.

The robust August numbers will intensify the debate about when China should begin withdrawing some of the massive fiscal and monetary stimulus it has injected into the economy since the end of last year.

However, the dramatic increases in new lending and money supply this year, combined with rising property and equity markets, have raised fears that government policies are creating a series of bubbles in the economy.

Bank loans rose by Rmb410.4bn in August after increasing by Rmb355.9bn the month before, and by Rmb271.5bn in the same month last year, while the M2 measure of money supply increased by 28.5 per cent.

Quite where and how all this will end in the longer run is frankly anyone's guess, since I personally can't recall an economy with these characteristics in this type of situation before. That is, we have an economy which normally runs a large trade surplus, and has massive foreign exchange reserves falling back on a massive dose of government spending, pressing what Krugman would call Keynes button "G" three or four times consecutively in order to finance an orgy of lending and unaffordable housing construction, which may all be comfortably written off in the future if the global economy eventually recovers and China can blitz the planet with products from all that currently "excess to requirement" capacity that is steadily being built up. All we can say is, hold on to your seats, and keep your eyes peeled to the screen, since whichever way this goes it is surely going to be interesting.

China's GDP Growth Rate Continues To Recover

China looks as if it could hit its full-year growth target of 8% after a surprisingly strong second quarter which was distinguisjed by a strong surge in investment driven by powerful fiscal and monetary stimulus. Annual gross domestic product growth accelerated to 7.9% from 6.1% in the first quarter, making China the planet's best-performing major economy. The acceleration in China's economic growth follows the application of a 4 trillion yuan stimulus package, record lending and a rebound in property investment and sales that have to some extent offset the slump in the nation’s exports. Consensus economists now anticipate China’s GDP growth will accelerate to a 9.5 percent pace next year following an 8.3 percent rate in 2009,

The most recent data suggest that China is likely to show a further growth increase in Q3 from the acceleration in Q2. While exports continue to deteriorate on an year on year basis, they are now managing to squeeze out some sort of increase on a month by month basis.

China's growth really has been quite robust for more than 20 years now, and even though it dropped back somewhat after the 1998 crisis, it never really fell below 8% or so annually averaged over time. Which has to lead you to ask yourself just how much of that export driven surge post 2002, which was fuelled by massive credit in a number of developed economies, really is sustainable? Trend growth at this point is likely to be nearer to 7% a year than it is to 10%.

China is now well on the way to becoming the world's number two economy, behind the United States. In this sense, if China does manage to head straight forward full speed ahead this will mean the current recession will have been decisive as Japan and Germany slump inexorably backwards. These latter two countries just don't have the internal leverage to run the kind of stimulus programme China is applying due to the weight of their ever more elderly population.

Industrial Output Bounces Strongly Back

China’s industrial production rose more than forecast in August, lending unexpectedly climbed and retail sales advanced, indicating growth in the world’s third- biggest economy is likely to accelerate. Industrial output expanded by a 12-month high of 12.3 per cent in August from a year earlier after a 10.8 per cent increase in July, although production in August last year was held back by Olympics-related factory closures.

GM sales in China last month jumped to 152,365 vehicles,up by more than 100 percent over last year, as tax cuts and stimulus measures spurred demand. The company are forecasting 2009 sales to rise by more than 40 percent from 1.09 million last year. Total output for all carmakersmakers may increase by around 28 percent this year to as many as 12 million, according to China’s leading planning agency earlier this month. Car production accounts for about 2 percent of GDP.

And Investment Surges

Fixed asset investment inched up to a rate of increase of 33 per cent over August last year, after expanding by 32.9 per cent in July. Investment in real-estate development grew 14.7 percent in the first eight months after an 11.6 percent gain in the first seven months, the statistics bureau said yesterday. House prices in 70 cities rose 2 percent in August, the fastest gain in 11 months.

Overcapacity is now a serious problem in China. According to a recent report authored by the Financial and Economic Affairs Committee (FEAC) of the National People's Congress (NPC), nineteen industries are currently plagued by problems of overcapacity, although the report failed to provide a detailed list.

The number of industries thought to be effected has now almost doubled since the State Council first began addressing the problem of overcapacity back in 2005.

The FEAC report noted that when the new round of stimulus package investment was unleashed last October, local governments expanded production capacity with no regard for the consequences and some projects were constructed without preliminary assessment or approval from higher authorities.

Liu Manping, a researcher with China's National Development and Reform Commission (NDRC), recently admitted that local governments favoured the construction of large industrial projects since they tended to be the impulsive response of local governments to the sudden access to easy money. Liu also explained that local authorities often split large projects into smaller schemes in order to avoid requiring approval from the NDRC.

The real problem is that the Chinese authorities largely rely - in their attempts to eliminate outdated production facilities - on administrative measures (direct orders to close) rather than market oriented ones.

All too often these measures either have a limited impact, or they are intentionally circumvented.

Chen Ling, deputy-director of China's Metallurgical Economic Research & Development Center, spoke recently about the early days of the campaign against overcapacity in the steel industry,when the government ordered producers with blast furnaces smaller than 200 cubic meters to close their doors.

Upon hearing such news, many small steel mills simply upgraded their blast furnace so that they now use 300 cubic meters, or even larger, blast furnaces. Later, the government again raised the cut-off to 300 cubic meters, but by continuing to increase the size of the blast furnace limit, the government simply pressured steel makers to once again enlarge their blast furnaces and thus production capacity continued to expand.

China is now well on the way to becoming the world's number two economy, behind the Unietd States. In this sense, if China does manage to head straight forward full speed ahead this will mean the current recession will have been decisive as Japan and Germany slump inexorably backwards. These latter two countries just don't have the internal leverage to run the kind of stimulus programme China is applying due to the weight of their ever more elderly population.

And Retail Sales Maintain Their Strong Momentum

Retail sales grew 15.4 per cent from a year earlier as domestic demand remained robust. Sales of motor vehicles were strong, up 34.8 per cent, as a result of government subsidies and tax cuts.

But Exports Wobble In August

Exports fell for a 10th straight month. The decline in imports was the biggest in three months and more than economists estimated. Exports rose 3.4 percent in August from July on a seasonally adjusted basis, the customs bureau said. Imports rose 1 percent. So month-on-month gains were smaller than in July, when exports rose 5.2 percent and imports climbed 3.5 percent

However. in spite of forecasts that exports might start to rebound on the back of restocking in developed economies, the rate of decline in exports increased to 23.4 per cent in August compared to the same month last year, after dropping 23 per cent in July. Imports fell by 17 per cent after declining 14.9 per cent in July. This led the monthly trade surplus to increase again to $15.7bn after recording a $10.6bn surplus in July.

Deflationary Pressures Nonetheless Eased Slightly

Deflationary pressures eased, with consumer price inflation falling 1.2 per cent in August. The rate of decline was nonetheless down from the 1.6 per cent seen in July.

The producer price index was down 7.9 per cent from the same period in 2008.

Saturday, June 20, 2009

Facebook Links

Quietly clicking my way through Bloomberg last Sunday afternoon, I came across this:

Facebook Members Register Names at 550 a Second

Facebook Inc., the world’s largest social-networking site, said members registered new user names at a rate of more than 550 a second after the company offered people the chance to claim a personalized Web address.

Facebook started accepted registrations at midnight New York time on a first-come, first-served basis. Within the first seven minutes, 345,000 people had claimed user names, said Larry Yu, a spokesman for Palo Alto, California-based Facebook. Within 15 minutes, 500,000 users had grabbed a name.

Mein Gott, I thought to myself, if 550 people a second are doing something, they can't all be wrong. So I immediately signed up. Actually, this isn't my first experience with social networking since I did try Orkut out some years back, but somehow I didn't quite get the point. Either I was missing something, or Orkut was. Now I think I've finally got it. Perhaps the technology has improved, or perhaps I have. As I said in one of my first postings:

Ok. This is just what I've always wanted really. A quick'n dirty personal blog. Here we go. Boy am I going to enjoy this.
Daniel Dresner once broke bloggers down into two groups, the "thinkers" and the "linkers". I probably would be immodest enough to suggest that most of my material falls into the first category (my postings are lo-o-o-ng, horribly long), but since I don't really fit any mould, and I am hard to typecast, I also have that hidden "linker" part, struggling within and desperate to come out. Which is why Facebook is just great.

In addition, on blogs like this I can probably only manage to post something worthwhile perhaps once or twice a month, and there is news everyday.

So, if you want some of that up to the minute "breaking" stuff, and are willing to submit yourself to a good dose of link spam, why not come on in and subscribe to my new state-of-the-art blog? You can either send me a friend request via FB, or mail me direct (you can find the mail on my Roubini Global page). Let's all go and take a long hard look at the future, you never know, it might just work.

Thursday, June 11, 2009

China's Imports and Global Recovery - Brad Setser Need Be Curious No Longer

Earlier this week Brad Setser was opining on his blog:

“Like everyone else, I am curious to see what China’s May trade data tells us. If China truly is going to lead the global recovery, China needs to import more – and not just import more commodities for its (growing) strategic stockpiles.”

Well Brad need restrain his curiosity no longer, since just this very morning we have learnt that:
China’s exports fell by a record in May as the global recession cut demand for goods produced by the world’s third-largest economy. Overseas sales dropped 26.4 percent in May from a year earlier. That compares with the median estimate for a decline of 23 percent in a Bloomberg News survey of 15 economists, and a 22.6 percent contraction in April.

The decline was the biggest since Bloomberg data began in 1995. And more to the point as far as Brad is concerned China’s imports dropped 25.2 percent last month, compared with a 23 percent fall in April. Hence China just one more time ran an increased trade surplus (up to $13.4bn in May from $13.1bn in April), and it is no clearer to me than it is to Brad how a country running a trade surplus can be leading a surge in global demand. Indeed this months data, far from prodiving evidence of an accelerating "recovery" continues to point towards ongoing weakness in global demand, just like the evidence we are receiving from Germany, and from Japan.

Of course, these are year on year numbers. Month on month, exports seem to have stabilised since the start of the year, while imports are undoubtedly up. As Danske Bank put it in a research note today:

The development in China’s exports was weaker than expected. According to our own seasonally adjusted data, exports edged up slightly and the overall picture remains that China’s exports have stabilised in recent months. However, the rebound in China’s exports since early this year has been weaker than in most other Asian countries, suggesting that the Chinese recovery story has been a major driver in Asian countries’ export recovery in recent months.

This is confirmed by the continued strong growth in China’s imports. According to our own seasonally adjusted figures, China’s imports soared ahead 5.8% m/m in May following an 4.9% m/m impressive jump in imports in the previous month. China’s imports of commodities such as iron ore, coal and crude oil have been extraordinarily strong, increasing speculation that China is currently building strategic inventories of the most important commodities (see chart on next page). For that reason, Latin America (not least Brazil) and the ASEAN countries have benefited recently from China’s strong import volumes.

What matters is not so much the fact that imports are rising, but what exactly the imports are. There is substantial evidence accumulating that - as Brad suggests - China is simply stockpiling commodities as a hedge against future inflation. Some of the best evidence for this came here, yesterday. If this picture is correct, then the situation is unsustainable, as is the run up in commodity prices and stocks which have accompanied it. I note Forex Blog draws similar conclusions this morning:
I would argue that the sustainability of this rally (both in stocks and in currencies) hinges on a return to GDP growth in emerging markets. [The IMF forecasts 1.6% growth in 2009 and 4% in 2010]. But given the gap between share prices and earnings, I’m frankly not convinced that investors actually care about whether the rally is supported by actual data. Instead, investors have complacently been swept up by the same herd mentality that produced the bubble of 2008, and could potentially lead to a rapid and painful collapse in what looks to be the bubble of 2009.

Investment Bonanza?

On the other hand there was a 38.7 percent year on year rise in fixed asset investment in May. This was an even larger increase than the one registered in April, when FAI rose 33.9 per cent. For the first five months of this year, investments increased 32.9 per cent from the same period in 2008, compared with 30.5 per cent in the first four months of the year and against an estimate of 31 per cent. According to Alaistair Chan, at Moody’s Economy.com.

“Fixed asset investment in China continues to increase on the back of state-directed projects ... This will help keep the economy growing but there are increasing concerns about the amount of lending that has been required to fund the projects"

Quite. And as a Chinese economist friend wrote me to say: "just how much of the current property demand is speculative? I also have my doubts whether even official inventory levels accurately reflect all the inventory out there, especially when I read anecdotes like this ... "

As a Beijing homeowner myself, I’ve experienced this puzzling phenomenon firsthand. We have been told that the value of the condo we bought last year has gone up 30% based on sales of new nearby developments, but it’s impossible to confirm since there is no secondary market. Originally we tried to rent the place, but we couldn’t find takers at any price that could remotely cover the mortgage, despite a prime location. When we decided to move in instead, we discovered that while the building was sold out long ago, hardly anyone actually lives there. Same with another 800-unit project down the street: every unit went for top dollar well before completion, but now the lights are off and nobody’s home.

In fact the volume of empty apartments across the country hit 91million sq metres at the end of last year, up 32.3 per cent from a year earlier, according to official figures. But those numbers included neither the huge volumes of completed real estate projects whose owners are waiting for market conditions to improve before they put them on the market, nor the estimated 587 million sq m of apartments sold in the past five years but left empty by their owners.

And that part of fixed investment which is ending up, not in flats for inventory, but in productive capacity. Well, as MacroMan says this morning:
But as capex growth keeps humming along..(we could ask)..does the world really need more manufacturing capacity at this juncture? .....(it all)...of course, begs the question of who the Chinese plan on selling to. It's all well and good continuing to build factories and export capacity, but the real world isn't like Field of Dreams; just because you build it doesn't mean that customers will come. Yesterday's US trade figures were telling in that regard. Imports declined again in April; while an inveterate "second derivative" believer may find reasons for optimism in the slight lessening of the pace of import decline in yesterday's data, Macro Man is rather more sceptical. And the fact that US exports declined as well suggests that domestic demand in the rest of the world remains flaccid at best.

So, and finishing up where I started, with the trade balance, as Brad said: "China needs to import more – and not just import more commodities for its (growing) strategic stockpiles". However, to quote again my Chinese economist friend: Macroman's data on China's imports of commodities is surreal too. To which Claus Vistesen responded: "Yep, this was what I thought, and we should expect Brad Setser to be all over this". We certainly should, we certainly should. On you go Brad.

Wednesday, June 10, 2009

China's Prices Continue To Decline As Industry Recovers (Updated)

Consumer prices fell again in China in May, although less sharply than they did in April. This lead some to hope that deflationary pressures are begining to ease, but I think it is far too early to start drawing this kind of conclusion. Indeed, like Brad Setser:

"I am curious to see what China’s May trade data tells us. If China truly is going to lead the global recovery, China needs to import more – and not just import more commodities for its (growing) strategic stockpiles.”
The consumer price index fell 1.4 per cent from a year earlier, compared with a 1.5 per cent decline in April, marking the fourth straight month of falling prices. On a month-on-month basis, the National Bureau of Statistics said the CPI dropped 0.3 per cent from April’s level.

The decline in food prices eased significantly, from 1.3 per cent in April to 0.6 per cent in May. Prices of non-food items, however, fell 1.7 per cent last month, more than April’s 1.5 per cent. However, the producer price index, which measures prices paid at the factory gate, fell 7.2 per cent in May. This was sharper than the 6.6 per cent fall in April.

Manufacturing On The Rebound?

The CLSA China Purchasing Managers Index rose to 51.2 in May from 50.1 in April, making May the second consecutive month the CLSA PMI was above 50.0, after eight months of being below the critical line. The rate of destocking increased in May, which was encouraging given there is some anecdotal evidence that production may be running ahead of orders. On aggregate the reverse seems to be true. The CLSA China PMI is compiled by U.K.-based research firm Markit Economics. The export order index increased to 50.1, the first expansion in 11 months. The output index fell to 56.9 from 57.4 and the new order index dropped to 56.2 from 56.6.

In fact in China there are two indexes, a fact which has lead to some controversy. The second index produced by the government-backed Federation of Logistics & Purchasing has repeatedly shown slightly higher readings, a feature which may be the result of giving a slightly larger weighting to the state enterprises, which are more oriented towards the domestic market. The May PMI saw the CFLP benchmark reading fall to 53.1 in May from 53.5 in April. This was the third consecutive month this index has held above 50.

So despite a good deal of controversy about what exactly is happening in China, and how sustainable what is happening actually is, it does seem that, for whatever reason, manufacturing industry is expanding at this point.

China’s Industrial Production Figures Press Leaked

The 21st Century Business Herald have reported China’s industrial production ahead of the official release date. The report says fixed-asset investments for May, due out Thursday, will show a 32.9% rise, while the month's industrial production and retail sales, due Friday, will post gains of 8.9% and 15.2%, respectively.

The figures were apparently derived from data circulating within government days ahead of public announcement. Reports in the mainland Chinese "21st Century Business Herald" and in Hong Kong's "Ming Pao" had already managed to predict the above consumer and producer price results ahead of today's official release, which raises questions about what exactly is going on here.

The accuracy of these newspaper forecasts is better than those of most economists, raising more than just eyebrows. Merrill Lynch said the results, rather than being a lucky coincidence, show that the "whispered numbers" referred in the reports are reliable. "Today's release confirms those whispered inflation numbers, meaning other whispered numbers are likely to be highly credible," Merrill Lynch analysts said in a research note today.

Retail Sales, Industrial Output and New Lending Data

China’s new lending doubled in May and industrial output and retail sales climbed pretty much in line with the data which was leaked earlier in the week by 21st Century Business Herald (see above).

New loans jumped to 664.5 billion yuan ($97 billion) from 318.5 billion yuan a year earlier. Industrial-output growth accelerated to 8.9 percent year on year and sales rose 15.2 percent.

Today’s data add to accelerating fixed-asset investment and surging auto and property sales in signaling that rapidly growing bank lending is succesfully countering the exports slump - for the time being anyway. But this very same record lending is stoking concern that China’s recovery may come at the expense of inflating asset bubbles and adding to the bank bad loan books.

M2, the broadest measure of money supply, rose 25.7 percent in May from a year earlier, according to central bank data, following a record 26 percent gain in April. Fitch Ratings said last month that it’s “increasingly wary” of China’s banking industry as it expects an increase in bad debts, and the nation’s banking regulator has urged lenders to ensure they don’t loosen management of loans.

Societe Generale note the following in today's research report:

China’s growth moving into dangerous territory

To describe the economic support measures in place in the Chinese economy as expansionary fiscal policy is not entirely correct. For the money is not being handed out from the public purse. It is being handed out by the Banks. Sure, they are acting as fiscal agents for Beijing, but the point highlights how China is enjoying a heady liquidity boom. It has been these liquidity booms that have always tripped China up....... and requires liquidity drainage that often overshoots. Given Chinese banks extended nearly CNY5trn of lending in the first quarter alone, this was equivalent to 70% of GDP, These liquidity booms are the types that China has always gotten into...... The sheer size of lending in the first quarter was equivalent to around 70% of that quarters GDP. Full-year lending is now likely to be close to CNY10trn – equivalent to nearly 30% of 2008 GDP.

On the face of it, China's car industry is among the winners from government efforts to spur growth, as China extends its lead over the U.S. as the world’s biggest auto market this year, with output climbing 29 percent in May. But is this as simple as it seems. As they say here, perhaps not:

At the same time, though prices vary from city to city, it is fair to say
China’s housing market which is said to have dropped 20% since this time last
year has largely made that back up this year as prices have rebounded.

All in all China looks in robust health and set to resume its place as
the engine of world growth just as soon as the rest of the world gets its act
together – right? Well we hate to be Doubting Thomas’s but well we have our
doubts. Those house sales have been supported by easy loans and reduced interest
rates. That is a phenomenon that the government could keep in place for some
time, years possibly providing the housing market doesn’t begin to overheat
again. But exports are still down, by 20% year over year according to the well
respected Brad Setser, ignoring the fact the market added another 30% in Q3 2008.

There are some apparently contradictory numbers coming out of China at
the moment. Take those car sales as an example. Our man on the ground tells us
BYD, a noted Chinese car maker, reported 30,000 car sales of one model by end of
last year, but the number plate agency recorded only 10,000 new cars of that
model registered for use on the road. What happened to the other 20,000 are they
running around without number plates? In a police state, I don’t think so. Our
understanding is auto sales are recorded in China when they leave the factory,
not when they are registered on the road, so dealers can build up inventory
while car “sales” are rising.

Monday, May 11, 2009

China's Manufacturing Industry Expands In April While Prices Fall (Updated)

China’s manufacturing expanded for the first time in either eight or nine months (depending on which index you chose - see below) as the decline in export orders moderated and investment surged on the back of the government’s 4 trillion yuan ($586 billion) stimulus package.

The CLSA China Purchasing Managers’ Index rose to a seasonally adjusted 50.1 in April from 44.8 in March.

The output index climbed to 51.3 from 44.3, the first expansion in nine months, while the reading for export orders rose to 48.8 from 41.4 in March. The total new-orders index climbed to 50.9 from 43.6 and the employment index rose to 50.9 from 47.1, the first expansions in nine months for both measures.

On the other hand the official (government sponsored) China Federation of Logistics & Purchasing manufacturing index also showed growth, in this case for the second consecutive month, with the headline index rising to 53.5 in April from 52.4 in March.

There are various differences between the two indexes (for a summary of the issues raised see my last month's post here), but the gist of the matter is that the government-backed measure is weighted more than the CLSA index toward large state-owned enterprises, which have benefited more directly from the government stimulus measures.

Is China Suffering Outright Deflation?

China’s consumer prices fell for a third month running in April and were down 1.5 percent from a year earlier, after falling 1.2 percent in March.

Producer prices fell 6.6 percent, following a 6 percent drop in March. The fall, which was largely produced by declining energy prices, was the biggest year on year drop since the turn of the century.

Bank lending also slowed in April, following three months of very strong growth. According to central bank Governor Zhou Xiaochuan lending was “approximately” 600 billion yuan ($88 billion) during the month, about a third of the record 1.89 trillion yuan in March. The official figure is due to be released this week. If confirmed, new loans of 600 billion yuan would be about 30 percent up on April 2008 which compares with a sixfold increase in March.

Update - Exports Fall Year On Year In April

The latest trade figures from China seem to confirm the idea that world trade is NOT taking off at this point. As a result China's economy is coming under a lot of pressure. While March overseas sales were down 17.1 percent from March 2008 - to $90.29 billion - in April exports were running at $91.9 billion, very slightly up on March, but 22.6% down on April 2008. In fact seasonally adjusted figures suggest a 32.8 percent month on month increase in exports from March and a 14 percent increase in imports, according to calculations from the Chinese Customs Bureau. So it is not all bad news. On the other hand we need to think about the fact that China currently has a lot more export capacity than it did a year ago.

Basically internal demand is largely being maintained by increasing government spending - hence the news that investment in factories and property jumped 30.5 percent from a year earlier in the first four months of the year, thanks largely to the wave of bank loans for government stimulus projects - but this is only a stopgap.

China will have to await a rebound in global trade (and we have no idea when that will come, or how) and grit its teeth in the meantime. The OECD currently forecasts that global trade will shrink 13 percent in 2009 as banks cut back on credit to exporters and importers, so there is still some considerable way to go with all this.

Industrial Ouput Growth Slows

China’s industrial output growth slowed to an annual 7.3 per cent in April, from 8.3 per cent growth in March, only adding to all the doubts over whether a Chinese recovery really is under way. The growth in factory output last month was less than half the year-on-year rate achieved in in April 2008 and most of the growth seems to have been a result of the government’s economic stimulus measures.

But retail sale growth remained reasonably healthy in April, rising by 14.8 per cent from a year earlier (to Rmb934.32bn). This was a similar rise to March’s 14.7 per cent growth. Since these numbers are not price adjusted I have created a "home made" price adjusted version, which can be seen for comparative purposes in the chart below. As we can see, nominal (current price) sales growth was much higher than real growth during the inflation burst, but the nominal chart drops below the skyline as deflation sets in an prices start to fall. This then is a fairly graphic illustration of what deflation means, since we can now expect this real/nominal disparity to continue, making everyone's economic decision making just that bit more difficult.

Another factor adding to the general state of confusion were figures released by the government on Wednesday that showing that electricity production, which is often regarded as a proxy for economic growth in China, fell by 3.5 per cent from a year earlier in April. When asked, government officials have been repeatedly unable to explain how industrial production can be growing while electricity production is falling. Since it is unlikely that Chinese industries are making large advances in energy conservation the most probable explanation is that the current slowdown has had a more severe impact on energy-intensive heavy industry. One example of this would be that China’s crude steel output fell 4 per cent in April from March. Below you can see the OECD leading indicator chart (which includes electricity output), and this may give is the nearest indication we are going to get of the path of the Chinese economy in recent months.

According to the stats office, total investment in fixed assets were 3,708.2 billion yuan from January to April, a year-on-year rise of 30.5 percent. Of which, state-owned and state-holding enterprises invested 1,605.5 billion yuan, surging 39.3 percent, while real estate development, valued at 729.0 billion yuan, went up only 4.9 percent. I think this just about says it all. Exports are way down, real estate is stalled, and output is being ramped up in the state run light industry sector, and in civil engineering.

And right now, as mention in the post above, internal price deflation is steadily setting in while the rate of new loan growth is slowing. So, hold tight everyone, this could get to be a bumpy ride.

Wednesday, April 01, 2009

Manufacturing Industry Contracts Again In March (Update 2)

China’s manufacturing industry shrank for an eighth straight month in March as collapsing global trade cut exports and growth across Asia. The CLSA China Purchasing Managers’ Index dropped to a seasonally adjusted 44.8 last month from 45.1 in February. Any reading on these indexes below 50 means contraction.

The manufacturing component of the index continued to increased, rising for a fourth month from a record low of 40.9 in November. The export orders index rose to 41.4from 39.5 in February. New orders climbed to 43.6 from 44.2. Output gained to 44.3 from 43.9, while the employment index rose to 47.1 from 46.6, its second increase in eight months.

“A worsening of domestic manufacturing orders lies behind the drop in the PMI and accords with what we are seeing on the ground in the steel industry,” said Eric Fishwick, head of economic research at CLSA in Hong Kong. “Expect the production index to show softness in April......More encouragingly, export orders continue to improve,” he added “They are still falling but at the most moderate pace since October.”
Update: Rival Indexes At Work (Thursday 8 April)

Well, following a question in comments (see below) I think it worth adding a few details about the "other" PMI reading which is available, the China Federation of Logistics & Purchasing (CFLP) one. The CFLP PMI rebounded to 52.4% in March 2009, up from 49.0% in the previous month. The index was back to the expansionary zone of higher than 50% for the first time since October last year. Output index, new orders index and purchases of inputs index were also higher than the critical level of 50% in March. Except stocks of finished goods, all sub-indices were higher than their respective levels in the previous month. Of which, imports index grew strongly by 7.0 ppt. to 48.8% in March, compared to the previous month.

Many commentators have taken the CFLP reading at face value without bothering to contrast. Thus Bloomberg's Li Yanping, in a very bullish article:

China’s manufacturing expanded for the first time in six months, spurred by the government’s 4 trillion yuan ($585 billion) stimulus package. The Purchasing Manager’s Index rose to a seasonally adjusted 52.4 in March from 49 in February, the Federation of Logistics and Purchasing said today in Beijing in an e-mailed statement. A reading above 50 indicates an expansion. The expansion may help President Hu Jintao achieve his target of 8 percent economic growth for the world’s third- biggest economy. The report comes as he attends a Group of 20 summit in London where world leaders are discussing remedies for the worst global recession since World War II. Hu’s stimulus package already triggered jumps in urban investment and loan growth in the first two months of this year.
or PNB Paribas:

China Logistics Information Center (CLIC) release March PMI rose to 52.4 from 49 of February, the fourth months of continues improvement. PMI breached 50 the first time since September 2008, suggesting the industrial sector is resuming sequential expansion after 5 months of continuous drop.

Overall, the NBS PMI suggest that March industrial sector resumed sequential expansion despite further deterioration of export, this recovery is due to strong fiscal stimulus, aggressive credit expansion at 24.5% y/y pace and relative resilient household demand for property, autos and other durables. Though export outlook remain gloomy, however the G20 and global quantitative easing seem to be providing a floor to global demand. While Q2 growth should remain anemic, however the rebound of PMI suggests Q2 domestic demand growth is on an increasingly firm footing.

PNB Paribas basically put the difference down to differences in sample size:

The widening gap between CLIC PMI and CLSA survey PMI is due to different sampling, CLIC survey focused on 738 major industrials accounting for 20% of VAIO.
But as I indicate in comments, the difference is only in part about sample size, there is also a difference in methodology, largely connected with seasonal adjustment, not an un-important issue when the lunar new year impact is knocking around somewhere in the data. Indeed CLSA made this point abundantly clear in a note released alongside their report:

"It is true that the CFLP survey sample size is larger than that of the CLSA China PMI...therefore the standard error of the (population) estimates from the CFLP survey should be around 25 percent smaller than those from the China PMI," according to the CLSA note released on April 1. "However in practice all of this is academic. Differences in the samples are dwarfed by differences in how each set of statisticians adjust for seasonality in the data," said the note. CLSA said it had tuned the March figure as the February and March varied in number of days in a month and the latter month affected by the long Chinese lunar New Year holiday. Though both sides made seasonality adjustment, the CFLP figure was usually boosted by around three points by seasonality in March, said the CLSA note.

So you can accept the version you want to accept here, but be careful, since the level of confidence to be attached to either reading is moderate. At the end of the day the proof of the pudding here will be in the eating, when we get the March year on year industrial output data, ince this will either be just slightly up, or just slightly down on March 2008 -and remember in the meantime there has been a large expansion incapacity.

Second Update Monday April 13

And well, the mystery only deepens, since now we have an advance on the statistical data (thanks to Premier Wen Jiabao) and we learn that China's industrial output was apparently up by 8.3% year on year in March:

China's industrial output rose 8.3 percent in March, in a sign that a huge stimulus package is kicking in, Premier Wen Jiabao said in an interview published on Monday. Last month's growth accelerated from the 3.8-percent rise in the first two months as domestic demand continued to improve, Wen said, according to the China Securities Journal. Fixed asset investment and retail sales, which measure spending on infrastructure and consumption respectively, also increased quickly in the first quarter, he said in an interview while in Thailand for the ASEAN summit at the weekend. All this showed the economy was performing "better than expected" thanks to Beijing's measures to tackle the international financial crisis, he said. China in November unveiled an unprecedented four-trillion-yuan (580-billion-dollar) stimulus package to ward off the worst effects of the global crisis. However, Wen said the nation's export-dependent economy was still facing major difficulties due to a sharp contraction in foreign demand, which has placed increasing pressure on employment. "The international financial crisis has not yet hit the bottom. It's hard to say that China alone has steered away from the crisis," he said. "We should never overlook (the risks)." Wen's comments came just days before the National Statistics Bureau is slated to release first quarter data on the Chinese economy on Thursday. Tai Hui, an economist with Standard Chartered in Singapore, said the March growth in industrial output was boosted partly by companies filling their inventories after depleting them in recent months. However, the level of growth remains modest compared with before the crisis, and the overall economy is still weak, he said. "The economic environment,although it has improved, remains relatively weak due to the global financial turmoil," he said.
The mystery deepens in part becuase exports fell in March, more slowly than February, but still sharply - 17% yoy (following a 25.7% drop in Feb):

China's exports fell 17 percent in March, a less sharp contraction than the month before, amid signs the plunge in overseas demand may be easing, the government reported Friday. But while the decline in exports eased somewhat, a sharper weakening in imports pushed China's trade surplus to $18.56 billion, up from $4.84 billion the month before, the General Administration of Customs said. Exports totaled $90.3 billion in March, the fifth straight month of year-on-year declines due to the global downturn. In February, exports sank 25.7 percent from a year earlier in the worst drop in more than a decade. Imports in March fell 25 percent to $71.7 billion, the customs data showed. China's imports fell 24 percent in February. "The pace of contraction in exports has moderated notably from January-February levels, as export activity showed signs of stabilization," Jing Ulrich, chairman for China equities for J.P.Morgan, said in a report to clients. "Imports remained weak but there are some initial signs of recovery in China's raw materials demand, driven by government stockpiling and record imports of iron ore," she said.

It's frankly hard to understand why imports would be falling more than exports if you had a domestic demand lead recovery process at work. Brad Setser has a readable go at explaining things here:

The Wall Street Journal puts a more positive gloss on China’s March trade data than I would. To me the overarching story is simple: the data paint a story of deep distress in both the Chinese and global economy. China’s exports were growing 20% y/y (23% actually) in the third quarter of 2008. They were down nearly 20% (19.7%) in the first quarter of 2009. Imports though fell by more, in part because of the fall in oil prices. Imports fell close to 30% y/y in the first quarter. That isn’t just a function of falling commodity prices and fewer imported components either; US exports to China — which presumably include a lot of capital goods — are way down y/y. As a result, China’s trade surplus was larger in the first quarter of 2009 than in the first quarter of 2008 ($62 billion v $41 billion). The global shock has gotten rid of many of the world’s macroeconomic imbalances. American households are saving more and importing less, so the US deficit is down. The oil exporters are no longer running a surplus. Even Japan’s surplus has come down, as demand for Japan’s exports has fallen more rapidly than Japan’s commodity import bill. China’s surplus though has continued to rise.

So this is really the point I think: with a growing surplus (at this point, and on a year on year basis) China's economy isn't going to pull the rest of the world anywhere, since essentially it is still draining-off demand from elsewhere.

But even if China seems an unlikely candidate to pull the global train out of the mire, we still need to try and understand what it is exactly that is going on in Chinese domestic industrial activity. One part of the explanation undoubtedly lies in domestic loan growth. Bloomberg report that China’s new lending surged more than sixfold from a year earlier to a record 1.89 trillion yuan ($277 billion) in March, which compares with the previous high of 1.62 trillion yuan posted in January. Domestic loans grew 29.8% in March, from a year earlier - analysts had been expecting a 25.1% jump. M2 - often considered the broadest measure of money supply - grew year on year by 25.5 percent, according to the central bank.

Bloomberg report that this is the fastest growth rate for M2 since they began compiling data in 1998. China’s banks, which are mostly state-owned, have already implemented new lending almost up to the government’s target of 5 trillion yuan of new loans this year. Indeed, according to JPMorgan Chase & Co. lending may exceeed the target level by as much as 3 trillion yuan. China has certainly mounted the credit tiger in its race to meet the government's official growth target of 8% this year, but while growth propelled by government stimulus and easier access to credit may spawn new projects and stem job losses in China, it won't necessarily translate into industrial profits, and indeed in the medium term it may even lead to a large pile-up of Non Performing Loans.

While no one at this stage believes that the percentage of such loans could reach 2003 levels (20.4% of the total, or 16.5% of GDP) many believe the danger that Chinese vabks could see another wave of loan defaults is rising. This, is the view being taken, for example, by Fitch Ratings, who in a recent report warn that loan defaults could rise to 5% or 6% of total lending, as Euromoney's Sudip Roy argues:

The biggest proportion of new lending by the banks is through discounted bills, which supply working capital. Long-term to medium-term corporate loans are the second-biggest component. More than 70% of the new lending, according to official figures, is through these two channels, which should be low-risk financing."It is hard to predict the quality of all of the lending in January and February but a large proportion of it was mid- to long-term loans to infrastructure projects with stable funding and government support," says Lian Ping, chief economist at Bank of Communications in Shanghai... banks often categorize loans that are rolled over as performing even though they have not been repaid on their original maturity date. "In practice, this means that a one-year working capital loan that is not repaid at maturity can take another one or more years before being classified as nonperforming," says Fitch. Instead, many banks classify these advances as special mention or even normal loans. Special mention loans are effectively non-performing in all but word.

What’s especially worrying, according to Fitch, is that if a comparison is made for each of the 16 leading banks of the levels of their equity and loan-loss reserves against their portfolio of NPLs and special mention loans, then in every case the latter "swamped reserves, while for many banks equity also was severely affected". And these banks are the largest and healthiest in the country, adds Fitch.

In a sign that some of the lending is already reaching infrastructure and real estate projects China's National Statistics Bureau said on Monday that spending on property development was up from a year earlier by 4.1% in the first quarter, following a rise of only 1% in January and February. Property sales were also up year on year (by 8.2%) in the first quarter, after sliding in January and February. However urban real estate prices in 70 major cities were down 1.3% in March, compared with March 2008, confirming the general deflationary environment.

Further foreign direct investment into China fell for a sixth month in March, dropping 9.5 percent from a year earlier to $8.4 billion, as compared with a 15.8 percent decline in February. For the first quarter as a whole, spending fell 20.6 percent to $21.8 billion. Foreign-invested businesses account for 30 percent of industrial output, 55 percent of trade and 11 percent of urban jobs according to Commerce Ministry spokesman Yao Jian at the press conference where the FDI data were released. The rate of decline in FDI is slowing however, since while this is the first time since 2000 that investment from abroad has fallen for six straight months, the absolute value of investment in March was the largest in nine months and the decline from a year earlier was the smallest in the last three months. Thus it would be premature to draw any definitive conclusions at this point.

And just one more data point to add to all those quandrys, China’s March power output fell about 2 percent from a year earlier according to an official from the China Electricity Council, citing preliminary data. The drop is smaller than in previous months, the official said today, declining to be named before the official data release.

Power production fell 3.7 percent in the first two months from a year earlier, the National Bureau of Statistics said on March 12. Further, China's power output fell 0.7 percent in March from a year earlier, according to Caijing magazine on April 3, citing the State Grid Corp. of China, the country’s biggest electricity distributor. On the other hand China Central Television reported on April 11, citing the Electricity Council, that electricity use was up “noticeably” in March from February. Now this little snippet of information would appear at first sight to be at variance (but not in contradiction) with the March year on year data, until you consider the sort of seasonal influences we have been encountering in this post. So it is quite possible that power consumption was up sharply month on month, and down slightly year on year. What seems hard to understand, at least from where I am sitting, is how power consumption can have fallen while industrial output surges 8.3%. When you put this together with the import data, and the rising surplus, then something quite simply doesn't add up here.

This impression that all may not be moving as planned under the "official version" would seem to find some confirmation in the latest reports that the Chinese government is considering additional stimulus measures to boost consumption and bolster growth. According to a report in the official China Securities Journal - citing Gao Huiqing, a researcher at the State Information Center - the government will issue some “guideline” policies and continue to use fiscal and taxation measures to spur an expansion. This follows this weekends statement from Premier Wen Jiabao that China would “closely” monitor changes in the domestic and world economy and “hammer out” new response plans when needed.

Gao, who is affiliated with the National Development and Reform Commission, indicated that the kind of recovery mentioned by Premier Wen, spurred as it is by rebounding inventories and sales of property and cars, may be short-lived without a global rebound which will increase demand for Chinese exports.

“While the stimulus is indeed having an effect on loan growth and some measures of economic activity, the trend decline in exports is unbroken,” said James McCormack, head of Asia sovereign ratings at Fitch Ratings in Hong Kong. “Chinese gross domestic product growth will remain below potential until the global economy recovers.”

Indeed according to Zheng Xinli, the deputy policy research head of the Chinese Communist Party, China’s 2009 exports may shrink by as much 10 percent over 2008. So what we have here, is more like a make and mend, hold the line, stimulus approach, as the government tries to soften the external blow, rather than a full blooded, domestic demand driven recovery.

According to initial reports the new package is likely to be focused on social welfare spending and on boosting consumer consumption, both of which are to be fuelled by the record fiscal deficit China is expected to run this year. China is, for example, subsidizing 20 billion yuan this year on rural purchases of televisions and refrigerators and plans to increase spending on welfare by 29 percent. In the long term, the government is also planning an expanded social safety net, and the State Council published earlier this month an 850 billion yuan health-care plan, including building at least one hospital in every county and expanding medical insurance coverage to 90 percent of the 1.3 billion population by 2011. All welcome measures, but not surely the ones which will lead us all collectively away from the abyss.

Wednesday, March 11, 2009

Prices Drop As Exports Fall

Perhaps one of the most heated debates which is taking place among investors and economists at the present time relates to China. Economic growth plunged in the fourth quarter of last year, and the economy may even have contracted. Yet the government has lashed out "loads of money" on a huge stimulus programme. Will this work? The Jury is still out.

Certainly some sectors of the economy are suffering badly and China’s trade surplus plunged in February on the back of a record drop in exports. The trade gap narrowed to $4.8 billion - roughly one eighth of the amount registered in January, according to data from the customs bureau. China's trade surplus hit a record $40 billion in November. Exports dropped sharply in February - down 25.7 percent from a year earlier (following a 17.5% fall in January), while the collapse in imports slowed, falling by "only" 24.1 percent following January's record 43.1 percent decline.

Meanwhile China announced earlier this week that its consumer inflation fell for the first time in more than six years in February, suggesting we might now be entering a period of price deflation - the consumer price index fell 1.6 per cent from a year earlier in February. This followed a 1.0 per cent rise in January .

China's CPI last fell in December 2002, when it dropped 0.4 per cent, capping a year in which CPI fell every month save one. The latest data show the risks of prolonged general price declines - deflation - are rising. Beijing has targeted headline inflation of 4 per cent this year but it certainly now looks like the government will struggle to get prices back into positive territory and may have to confront a prolonged period of deflation. Food prices, a key component of in the Chinese CPI, fell 1.9 per cent in February from a year earlier; non-food prices fell 1.2 per cent.

And more evidence of possible deflation in the works comes from wholesale prices, since the producer price index fell 4.5 per cent in February from a year earlier, a steeper drop than January's 3.3 per cent decline.

Industrial Output Falls Back

China’s industrial-production growth slowed at the start of the year on the back of the export decline, with output rising only 3.8 percent in January and February from a year earlier, slowing from a 5.7 percent increase in December.

However China’s investment spending has maintained its momentum (and even increased), as the government pours money into roads, railways and power grids. Urban fixed-asset investment climbed by 26.5 percent in January and February from a year earlier.

Retail sales, on the other hand, have been slowing, and rose by 15.2 percent in February from a year earlier in current price terms (after a 19 percent rise in December) or by 16.8% in real (price adjusted) terms (given that prices fell year on year). The downward momentum in retail sales growth since the summer is evident on both measures.

Huge Loan Expansion

So the big question is to just what extent will the government investment programme help restructure the economy? Certainly it won't kickstart it, since the export sector is dependent on demand elsewhere, and that is unlikely to move in the near tyerm. However the emphasis in Chinese economic activity might be able to switch towards domestic consumption, and that is the big question we now face. Certainly bank lending has increased, with China’s new loans more than quadrupling in February (from a year earlier) as the government pressed banks to support a 4 trillion yuan $585 billion). The problem is, just how much of this lending can turn bad?

Banks extended 1.07 trillion yuan of local-currency loans in February and M2 climbed 20.5 percent from a year earlier, the fastest pace in more than five years, after growing 18.8 percent in January. The lending, which is in addition to a record 1.62 trillion yuan in new loans in January has given rise to concerns that the pace of new lending may be unsustainable and endanger the overall health of the financial system. Lax credit assessment now may lead to an upward surge in delinquencies in the months and years to come.”

Central bank Governor Zhou Xiaochuan said earlier this month that loans and money supply may have grown too quickly, since Premier Wen Jiabao announced a whole year target for lending of 5 trillion yuan, so that the banks are already halfway through their target with 10 months still to go. The surge in credit has also triggered concern that some of the money is being pumped into the stock market. The Shanghai Composite Index which tracks China’s largest stock exchanges is now up by 17 percent since the start of the year.

The worries about bad debts are being taken seriously, and China’s banking regulator have told banks to boost provisions to 150 percent of their outstanding non-performing loans, according to an article in the 21st Century Business Herald. The bad loan ratios of the country's five biggest banks -- Industrial & Commercial Bank of China Ltd., Agricultural Bank of China, China Construction Bank Corp., Bank of China Ltd., and Bank of Communications Ltd., is to be raised to 150 percent from 130 percent at the end of 2008, while the requirement for smaller national banks remains unchanged at 150 percent.

Liu Mingkang, chairman of the China Banking Regulatory Commission, has described such moves as "prudent", and in line with the regulatory decision to carry out spot checks on bank loan books to “ensure quality of growth”.

Rural Squeeze

But while the banks dole out the money, and stocks surge, China’s rural population are feeling the pinch as farm incomes drop this year on the back of falling agricultural prices.

“The pressure from declining agricultural prices is high,” Yin Chengjie, vice chairman of agricultural and rural affairs of the National People’s Congress, said in an interview in Beijing. “We cannot be optimistic about growth” in farm incomes this year, he said.

Prices of agricultural products - including cotton, soybeans and corn have fallen over the past year as bumper harvests swelled stocks and restaurant sales and food processing output declined. The net consequence is that the disparity between the urban and rural population is widening, and the situation is further aggravated by the large number of migrant workers who now find themselves unemployed and have returned to their villages.

And just to show that the export data isn't simply a one off problem, it is worth noting that the OECD leading indicators reading has been sliding steadily for months now, and continue on its way down in January regardless (see chart below). Also foreign direct investment in China fell for a fifth consecutive month in February.
Investment dropped 15.8 percent to $5.83 billion from a year earlier - according to the commerce ministry - compared with a 32.6 percent decline in January. So the stimulus programme is acting as a brake on the rate of decline, but we still have a decline. That, I think, is the best we can hop for at this point.

Thursday, February 12, 2009

Exports Tumble As China Enters Deflation

Is China about to lead the charge out of the current slump, or is the Chinese economy about to succumb to it? This appears to be one of the most interesting and most hotly debated questions of the moment. On the one hand the latest manufacturers PurchasingManufacturers Index seemed to suggest the contraction in China's economy slowed in January, while other data, in particular producer price inflation, loan growth, employment figures and movements in external trade seem to give a rather different impression.

External Trade Drops Sharply

China’s exports fell at the fastest rate in almost 13 years in January while imports fell completely off the cliff, plunging at the record rate of 43.1% year on year, indicating that the contraction in the world’s third-biggest economy may well be gathering rather than losing pace. Exports were down by 17.5 percent from January 2008.

Due to the massive fall in imports China's trade surplus remained high - at $39.11 billion it was the second largest on record - and this is almost guaranteed to add to tensions as global leaders seek to avoid a return to protectionism. China’s economic slowdown has already cost the jobs of 20 million migrant workers and the economy is now almost certainly contracting, rather than, as some argue, simply slowing.

Exports to the European Union fell 17.4 percent, while those to the U.S. were down 9.8 percent. Shipments of electronics goods dropped 21 percent. Steel slid 32.5 percent and toys declined 14.7 percent, although the numbers are possibly exacerbated by the week-long Lunar New Year holiday, which took place in January this year as opposed to February last year.

Chinese government researchers have already begun to advocate weakening the yuan against the dollar to support exports, and according to a report from the Ministry of Finance’s research institute published earlier this month China should “actively guide” the yuan to about 6.93 to the dollar to aid growth and boost employment, although there is no indication at this point that such a recommendation will be acted on.

It is very hard to know what is the actual present condition of the Chinese economy, since while it grew by 6.8 percent from a year earlier in the fourth quarter of last year - following a 9 percent in Q3 - this data point doesn't actually tell us too much about the current rate of expansion/contraction, and since things are changing very quickly this is quite important. The same goes for the official industrial output numbers which tell us output was up at a 5.7 percent annual rate in December, down from 17.4 percent a year earlier, but don't tell us what happened between November and December.

China Compared With The Other Asian Exporters

Some commentators are arguing that the drop in Chinese exports is not that severe if we compare it with the decline in other Asian countries, suggesting in effect that China is less export dependent than some of its neighbours.

“While the recent export slowdown has been alarming, China’s export slump has not been as severe as in some neighboring countries with a greater reliance on high-tech exports,” said Jing Ulrich, head of China equities with JPMorgan in Hong Kong. Taiwan’s exports fell a record 44 percent in January.

But this view seems to me to be misleading, and possibly ill-founded. According to a recent research report from DBS, two things stand out in the latest data. First, China’s exports to the US have obviously fallen considerably. In fact, they have fallen by around 9% since October (USD terms, sa, 3mma). Exports to Europe have also fallen by a similar amount. But Asia’s exports to China have fallen by four times more - or 37%. If China were simply passing along weak demand from the US and Europe to its neighbors, the drop in Asia’s exports to China ought to be roughly proportionate. So obviously they’re not.

DBS suggest that there is thus a huge disconnect between the fall in global demand for China’s exports and China’s demand for Asian exports.

Secondly , China’s demand for Asian exports starts to drop sharply in August, fully three months before China’s exports themselves begin to drop. A number of interpretations are possible at this point. One possibility is that the decline in other parts of Asia reflected a decline in new orders which only later hits China (in which case we should expect China's exports to take much stronger hits in February and March). Another is that China was the “leader”, not the“follower”, with much of the Asian exports being directed to fuelling China's internal investment boom. There is a third possibility here, and that is since China is very energy dependent, a significant share in the imports drop is a reflection of the fall in energy prices, since oil did, conveniently, peak in July 2008.

Possibly there is some truth in all these arguments, but, in terms of quantities and in terms of timing, there does seem to be something “autonomous”going on with Chinese demand. And if its not simply about the drop in demand from the US, what is it about?

Could the end of the Olympics bubble have something to do with the disconnect, and with the subsequent bust in Asian exports? It certainly seems to be more than a coincidence that China’s imports from Asia rise sharply in the run-up tothe August Olympics and then fall sharply immediately thereafter.

Price Changes Hit Deflation Territory

Prices in China have now started to fall, with producer prices dropping in January by 3.3 percent -the most in almost seven years. Consumer prices rose 1 percent in January from a year earlier, after gaining 1.2 percent in December, but these are year on year numbers, and the recent decline in month on month prices changes, despite a surge in food prices as we entered the Lunar New Year celebrations, have generally moved into negative territory.

In particular, food prices are usually higher during the Chinese new year celebrations and for that reason consumer prices were probably higher than usual in January. Despite inflation declining less than expected in January, there are signs that inflationary pressure is easing fast and it is likely that China will enter deflationary territory in the coming months. Inflation excluding food in January plunged from 0.6% year on year to -0.6% (see chart below).

The residential component showed an unexpected large drop from 1.1% year on year to minus 2.3%. Besides food - which is running just below 5% year on year - all the other major components are now in negative territory.

“Inflation could have been close to zero or worse if not for the Chinese New Year, because vegetable prices and grain prices went up,” said Wang Tao, China economist at UBS AG in Beijing.
McDonalds, the world’s largest fast-food chain, said last week that it was cutting the prices on some of its meals in China by as much as one-third to attract customers to its 1,050 restaurants across the country.

So my feeling is that we have now entered a deflationary period in China, of longer or shorter duration depending on whether or now the authorities are successful in turning the economy around. The rate of price deflation, and in particular in producer prices, will certainly give us one convenient indicator of the rate of contraction. Further, the inflation slowdown will put additional pressure on the central bank to cut interest rates, since the key one-year lending rates still stands at 5.31 percent - following a total of 2.16 percentage points in reductions at the end of 2008 following the collapse of Lehman Brothers. The central bank has not yet cut rates so far this year, despite the fact that with inflation now around zero, and the economy more than likely contracting, those 5 percentage points represent very tight monetary conditions. Of course, and looked at from another perspective, any further loosening in interest rates may well not be all that positive for the yuan.

Mind What You Say

During the lunar new year festival Chinese people send traditional greetings to each other, such as "Caiyuan gungun" (May prosperity come rolling to you) or "Xinxiang shicheng" (May you achieve all your desires). This year, festive well-wishers have had to be careful which salutations they choose. “Caiyuan gungun” has been virtually banned because it sounds exactly the same as the phrase meaning “laid off and discarded”. “Xinxiang shicheng” is also out of favour because it sounds suspiciously like the Chinese for “40 per cent pay cut”.

Giant Credit Surge In January

The Chinese government has now abandoned quotas for new credit growth and has urged state-owned commercial banks to offer finance for the Rmb 4,000bn ($586bn) fiscal spending plan which is due to run over the next two years. As a result there are now plenty of signs of monetary losening, among which is the fact that new loans rose at a record pace in January while the money supply expanded at the fastest pace in more than a year. Banks extended Rmb 1,620 bn of new local-currency loans and M2 climbed 18.8 percent from a year earlier. The new lending was equivalent in size to 40 percent of the proposed stimulus spending.

“Explosive lending growth is unsustainable and will likely decelerate,” said Ha Jiming, Hong Kong-based chief economist at China International Corp. “China may face increased risks going forward if the lending upsurge is coupled with declining loan quality and loosened lending terms.”
The biggest proportion of new lending, 39 percent, was through discounted bills, which could be though of as supplying working capital, rather than funding investment. Medium and long-term corporate loans accounted for 32 percent.

Also of note, consumer credit grew by 121bn in January, and this was almost evenly divided between short and long term credit. These together accounted for just 7% of total credit growth. The level of consumer credit growth was the largest in just over a year, but it was not far above the levels prevailing in 2007. Consumer demand in the holiday month should have been particularly strong in relation to the rest ofthe year, so this rather mediocre result suggest a weakness in the underlying dynamic of consumption growth that could become more apparent as the year progresses.

China Is At The Start, Not The Finish, Of The Slowdown

At this point in time it would seem highly premature to start speculating that China's economy may be turning the corner. Many have read the lates CLSA PMI survey, which showed the output index rose in January to 39.7 from 38.6 (which had been a record low) in December, as signs of turning the corner. New orders were even up to 39.9 from 37, while the export orders component rose to 36.3 from 33.6. So the situation was better in January than December, but it is SO important to remember that these sub-components all indicate ongoing contraction, and it is very, very early to start saying that all this has "bottomed".

The collapse of China’s export engine has obviously hit the most vulnerable first, and the Chinese authorities estimate that 20m of an estimated 130m rural migrant workers in China's industrial sector have lost their jobs and returned to home towns and villages. The implied 15.3 per cent unemployment rate among migrants is not captured in official jobless numbers, which measure only urban workers who register as unemployed. That official number rose to 8.86m people, or 4.2 per cent of the urban workforce, in December, but many specialists say this number vastly underestimates the true scale of the problem.

And in this environment it is hard to see the "big switch" to a consumption driven economy moving slowly, if indeed it moves at all.

Monday, February 02, 2009

China's Manufacturing Sector Continued To Contract In January

China’s manufacturing contracted for a sixth consecutive month in January as shrinking global demand hit the country's export-driven economy. The CLSA China Purchasing Managers’ Index rose to a seasonally adjusted 42.2 from 41.2 in December. Since any reading below 50 indicates contraction, even though the rate of contraction dropped (and has been dropping since November, see chart below) China's manufacturing sector (and hence China's economy) is still contracting. What we don't know at this point is how quickly China GDP is contracting, we won't know that till someone with the time and ingenuity devises a way to calculate a rough and ready quarter on quarter (seasonally adjusted) output indicator. Come on, be famous for a day, go out and do it (since the Chinese statistics office apparently have no interest in the matter), I would, but I simply don't have the time, since Europe, not China, is my focus. However, on a rough and ready, back of the envelope, basis my guess is that this months Chinese reading may be equivalent to something like a quarter on quarter contraction rate of around 0.5%, which means that what we have at this point is a 2% annual contraction rate, but we really need to see some actual data to calibrate all this a bit better I think.

In the CLSA survey, output index rose to 39.7 from 38.6 (which had been a record low) in December. New orders were up to 39.9 from 37. The index of export orders rose to 36.3 from 33.6. So the situation was better in January than December, but it is SO important to remember that these sub-components all indicate ongoing contraction.

My guess is that Chinese companies are squeezing costs and margins as far as the lemon will take it, since there is little evidence of any uptick in aggregate global demand for manufactured products, au contraire. My guess is also that they are grabbing market share by entering the supply chain in places they haven't been before. For example, Hafei Aviation Industry Co., China’s second-largest listed aerospace company, surged to its highest level in almost six months in Shanghai trading this morning after the announcement that it had formed a venture to supply composite-material components to Airbus SAS.

Airbus plans to give 5 percent of the work making parts for A350 airframes to Chinese companies in a bid to win market share in the world’s second-biggest aviation market. The planemaker has also opened an aircraft assembly line in China, its first outside of Europe.

Harbin Hafei will start production in September, and it plans to open a new plant by the end of 2010, Airbus said. Hafei, Avichina Industry & Technology Co. and Harbin Development Zone Heli Infrastructure Development Co. will each hold 10 percent of the venture. Harbin Aircraft Industry Group Co. will own a 50 percent stake. Airbus will have a 20 percent stake.

Unemployment Surges Dramatically

Chinese manufacturers also shed jobs last month at the fastest pace since the survey began in 2004, with the employment index falling to a record low of 45, so obviously as workers lose their jobs internal consumption is also affected, and we clearly have worse to come in the immediate future.

Chen Xiwen, a senior rural planning official, estimated that about 20 million migrant workers had lost their jobs because of the nation’s economic slowdown at a press briefing in Beijing today.

More than 20m rural migrant workers in China have lost their jobs and returned home as a result of the global economic crisis according to government figures, raising the spectre of widespread unrest in the authoritarian country. By the start of the Chinese New Year Spring Festival on 25 January, 15.3 per cent of China’s 130m migrant workers had lost their jobs and returned from manufacturing centres in the south and east of the country to their home villages or towns, according to Chen Xiwen, Director of the Office of Central Rural Work Leading Group, who was quoting a survey from the Ministry of Agriculture.

Government figures show that in recent years 6m to 7m new rural migrant workers a year have poured out of the countryside to fill the factories, construction sites and restaurants of the booming cities, which means the government must actually deal with as many as 27m new jobless in the countryside. On top of that, a survey by a government think-tank in December estimated 1.5m recent tertiary graduates in China were unable to find work by the end of November and universities and technical colleges are expected to churn out another 6.5m graduates this year. According to rough official calculations one percentage point of Chinese GDP growth creates around 1m jobs.

Chinese Premier Wen explicitly declined to rule out a devaluation of the yuan in an interview with the Financial Times today, although , he said that for the moment the government was content to keep the currency stable at what he considered to be a balanced and reasonable level.

Asked if China bore any responsibility for causing the financial crisis, as a number of economists believe, he stiffens and says in a low voice: “It is a ridiculous view.” But he makes it clear that Beijing will do whatever is needed to maintain growth at “about 8 per cent” this year. “Running our own affairs well is our biggest contribution to mankind,” he says. If necessary, some of the country’s huge stash of foreign currency reserves could be put towards this endeavour – a new plan to enable the use of reserves for domestic purposes is under discussion, he says.

“We must take forceful steps. Under special circumstances, necessary and extraordinary measures are required,” he says. “We should not be restricted by conventions. Success or failure depends on the pace and intensity of those measures.”

Mr Wen refuses to make an explicit commitment not to devalue the Chinese currency during the crisis – as the government did after the Asian financial crisis in 1997, a pledge that helped engineer the eventual recovery and won China a lot of prestige. But he does rule out any big shifts in the value of the Chinese currency.

“I want to make it very clear that maintaining the stability of the renminbi at a balanced and reasonable level is not only in the interests of China but also the interests of the world,” he says. “Many people have not yet come to see this point that if we have drastic fluctuation in the exchange rate of the renminbi, it would be a big disaster.”

The yuan fell 0.1 percent to 6.8471 against the dollar as of 12:23 p.m. in Shanghai today, a drop which is largely a by-product of the fall in the euro against USD.