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ECONOMY: March Chinese Economy Report
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Keep things in perspective: China’s USD 1.4 trillion GDP growth in 2011 and 2012's growth trajectory deserve more news headlines than the troubles of Greece.


altFor the past two months with the beginning of 2012, much of the global market has been consumed by the latest news about the Greek debt restructuring and their economic policies. Before we examine the latest developments of China’s domestic economy, here are a number of relevant points that Business Tianjin readers should understand about China’s largest export market and the problems it faces.

The relevance of the Greek economic problem is the precedent it may set for other so-called developed nations for debt restructuring as well as the future of the European Monetary Union (EMU),explains Jim O’Neil, Chairman of Goldman Sachs Asset Management.
In fact, the fiscal deficits and debt of developed countries such as the UK, US and Japan are much worse than the average of the Euro area.

With respect to the EMU, there is a more interesting point made by Quentin Peel of Financial Times. Peel argues that German Chancellor Merkel may push for not only a fiscal union of the EMU in the short term but also for a political union in the long term. Despite the remarkable challenge this long term plan faces, the likely path of the EMU is towards more integration rather than a break-up of the EMU due to Greece’s economic problems.

To keep things in perspective, Greece’s economic problem by itself is miniscule compared to the remarkable growth of China. China recorded USD 7.3 trillion annual 2011 GDP despite its slower growth rate in Q4 of 8.9%. In just a year, China’s economy grew by USD 1.4 trillion and China's economy is now about twice the size of Germany's and more than 10% of global GDP. Greece’s economy is somewhere between USD 300 to 350 billion. China created the equivalent of another Greece every 11 weeks in 2011, two new Turkish economies or one-half of a new UK, or 80% of a new India or Russia according to O’Neil.

Furthermore, China managed to improve the balance of economic growth in 2011 despite many hurdles: a global economic slowdown, increasing trade protectionism, a rise in domestic production costs, accelerating appreciation of the CNY and other unfavourable factors according to China Daily. Import growth of China was 4.6% higher than export growth and general trade grew by 29.2% compared to processing trade that grew by 12.7%. Furthermore, it is clear that the faster growth rate is moving to the West and North of China adding to the balanced growth of China as a whole.

Beijing sends a strong signal on monetary policy fine-tuning

New CNY loans and money supply growth in January fell well below economists’ estimates. Despite the distortion in data due to the Lunar New Year effect, it reflects a cautious stance by policy makers over loosening policy.

Chinese financial institutions extended CNY 738.1 billion of new loans in January, an uptick from CNY 640.5 billion in December, but well below expectations for CNY 1.0 trillion in a median survey of 16 economists polled by Dow Jones Newswires, data from the People's Bank of China showed.
 
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Every year it is difficult to exactly pinpoint to what extent data is distorted by the Lunar New Year because it reduces the number of working days in January when banks can extend loans.

China's new loans usually surge at the beginning of the year as banks have historically made a majority of their loans to clients in the first few months of each year to avoid losing quotas issued by regulators or facing abrupt policy changes, according to Dow Jones Newswire. New loans in January 2010 stood at CNY 1.39 trillion, compared with CNY 1.62 trillion in 2009 when Beijing was pushing ahead with a major stimulus program to offset the effects of a global financial crisis.

In response to this serious drop in demand for loans, the People’s Bank of China (PBoC) cut the reserve requirement ratio (RRR) by 50bp in late February. After this cut, effective as of 24 Feb, the RRR for large banks and small and medium banks have been 20.5% and 18.5% respectively.

The decision is part of Beijing’s efforts to engineer a soft landing for the economy as growth slows while inflation remains stubbornly high, wrote Financial Times.

“Both the pressure of growth moderation and that of price rises exist at the same time,” Jin Qi, assistant to the PBOC governor, said according to a press release. “The overall tone of the monetary policy will stay prudent.”

The PBOC announced its first RRR cut in three years in late November, reversing course from a series of six ratio increases last year. Many observers had expected another cut before the Lunar New Year in late January, but the bank used open-market operations instead to supply banks with short-term funds according to Financial Times.

“The delay in action appears to reflect a lack of consensus on the pace of economic slowdown and the impact of liquidity easing in the advanced economies,” said Citigroup in a research note.

China’s gross domestic product grew by 9.2% last year. But the growth rate dropped to 8.9% in the fourth quarter, the slowest rate in 10 quarters, and is expected to slow further in the current quarter.

“Despite January’s spike in CPI, Beijing policymakers clearly believe that the balance of risks for the economy is still biased towards growth risk,” said Qu Hongbin and Sun Junwei, economists at HSBC, in a research note. “This reserve ratio cut is a much needed move to maintain liquidity and boost growth.”

HSBC’s economists said they expected bigger new loans and at least two additional 50bp reserve ratio cuts in the coming months. “Interest rate cuts will remain a secondary monetary policy tool of choice. We only look for a 25bp interest rate cut when headline CPI falls below 3%, likely towards the middle of the year.”

However, some disagree. “Markets should not take this RRR cut as a sign of a bigger monetary easing,” said Ting Lu, China Economist at Bank of America Merrill Lynch. “We believe the RRR cut is merely part of the ongoing fine-tuning which was started in October 2011.”

China's broadest measure of money supply, M2, was up 12.4% at the end of January from a year earlier, lower than the 13.6% rise at the end of December, and below economists' expectations for a 13.8% rise.
 
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Inflation in China accelerated unexpectedly in January due to higher food prices during the Lunar New Year holiday. The consumer price index rose 4.5% from a year earlier, up from a 4.1% rise in December and above economists' forecast of a 4.1% gain.
 
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The pick-up in inflation breaks a five-month trend of moderating price increases, raising concerns that Beijing may not be able to loosen policy aggressively to support growth according to Financial Times.

However, economists expect inflation to resume its moderating trend and with economic growth slowing, the central bank is likely to have more scope for policy easing.

Companies and commodities market react to Chinese economic outlook
In recent years, Western companies hastily expanded into China in hopes to offset slowing European and US sales. However, these companies are faced with numerous sets of domestic economic problems and have started to realize that China is not the ultimate cure for sales growth.

In October 2011 ABB, the Swiss electrical engineering group, observed weaker demand for its power systems and process automation technology in China, where overall orders declined by 5% in the third quarter.

Now, as European and US industrials have begun reporting their latest quarterly figures, more companies have expressed caution on the short-term outlook in China according to Financial Times.

Siemens, the German industrial bellwether that makes everything from trains to gas turbines and medical diagnostic equipment, warned in January that Chinese orders had declined by 16% to EUR 1.4 bn in its fiscal first quarter, due primarily to weakness in industrial automation – a technology that is typically one of the first to register a slowdown due to short lead times.

In the US, Caterpillar, the manufacturer of construction and mining equipment, said it had also seen a drop in sales of new machines in China last year, although it had gained market share.

altOther western companies have not yet suffered a slowdown at all. Growth in Chinese car sales slowed last year after the government withdrew tax incentives for small-engine cars. But premium carmakers such as BMW and Volkswagen’s Audi were among foreign companies that continued to enjoy record sales, boosting suppliers according to Financial Times. Meanwhile, retail sales have remained robust. Apple said Chinese demand was “staggering” and “off the charts”.

Analysts believe western industrials should have few troubles withstanding a couple of quarters of slower growth, and with an average of about 10% of Chinese sales, exposure remains limited according to Financial Times.

Investment is likely to pick up this year if China, as expected, eases monetary policy further to support the economy. However, some economists believe the dynamics of the Chinese economy might change, meaning foreign industrials that profit from the country’s growth will have to change too. China’s property boom, for example, may become a thing of the past, explains Financial Times.

“China has no choice but to switch from an investment-driven to a consumption-driven economy. Infrastructure, construction and mining-related industries should see their growth rates wane accordingly,” according to Société Générale research.

Increases in wages will encourage greater industrial automation in China and China’s growing elderly population will require greater spending on medical equipment, the Société Générale report noted.

While western companies are experiencing a temporary slowdown of continued sales growth, the commodities market is performing well given positive expectations of China’s economic outlook. Metals recorded their best monthly performance in January since December 2010, with the basket of London Metal Exchange futures rising 10.9%, led by a 26.5% surge in the price of tin.

The rally in prices has reawakened talk of copper reaching USD 10,000 per tonne, a level briefly exceeded amid last February’s optimism but which looked increasingly unlikely as prices tumbled to a low of USD 6,635 per tonne in October. Since the start of this year, the red metal has risen 11% to trade on Wednesday 1 February at USD 8,440 per tonne.

The rise in copper, a bellwether for global industrial production thanks to its widespread uses in construction and manufacturing, underscores a shift in perceptions about the global macroeconomic outlook in recent weeks. The rally in metals has also lifted sentiment towards the mining industry, with the FTSE European mining index rising 17.4 percent since the start of the year.

Looser monetary policy in China has encouraged Chinese industrial companies to import record amounts of copper in December 2012. As the EMU debt crisis fear dissipates for now by the emergency action from the European Central Bank, we will likely see a pick up in the commodities market.

 

By J. Hernan
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