There were two reasons for today's big initial market move: one was the realization that the next LTRO could be massive to quite massive (further confirmed by a report that the ECB is now seeking a "Plan B [14]"), the second one was that, somehow, even though China's economy came in quite better than expected, and much better than whispered, the market made up its mind that the PBoC is now well on its way to significant easing even though inflation actually came in hotter than expected, and virtually every sector of the economy, except for housing, is still reeling from Bernanke's inflationary exports. While we already discussed the first matter extensively earlier, we now present some thoughts from Standard Chartered, one of the most China-focused banks, to debunk the second, which in a note to clients earlier summarized "what the economy is really doing and where it is going" as follows: "If anything, today’s data is another reason not to expect a quick move to further loosening. The economy is slowing, but not dramatically – so far." This was subsequently validated by an editorial in the China Securities Journal which said there was no reason to cut interest rates in Q1, thereby once again confirming that the market, which in its global Bernanke put pursuit of interpreting every piece of news as good news, and as evidence of imminent Central Bank intervention, has once again gotten ahead of itself. And as the Fed will be the first to admit, this type of "monetary frontrunning" ironically make the very intervention far less likely, due to a weaker political basis to justify market intervention, while risking another surge in inflation for which it is the politicians, not the "independent" central banks, who are held accountable.
So how does Standard Chartered rate the Chinese economy overall? As it stands, everything, except for housing, which just recorded a drop in 52 out of 70 cities in December, is doing quite well.
From the report:
Officially, China’s GDP grew by 8.9% y/y in Q4, better than the market consensus of 8.7%. According to our estimated q/q seasonally adjusted annualised rate (SAAR), growth accelerated to 9.3% in Q4 from 8.5% in Q3, as we show in Chart 1. We cannot square this with the official q/q growth numbers: 2.0% in Q4, down from 2.3% in Q2 and Q3.
Beneath this strong figure, an investment-led slowdown is in play. Fixed asset investment (FAI) fell sharply in Q4. In nominal terms, y/y FAI growth dropped to 20.4% in Q4 (from 29.5% in Q3), and in real terms it slid to 12.3% from 20.6% prior (see Chart 3). This is where the slowdown is concentrated as both infrastructure and the property sector suffer a continuing credit crunch.
Industrial production (IP), however, remains robust, growing 12.8% y/y in December (against 12.4% in November). The National Bureau of Statistics (NBS) even claims that IP grew by some 1% m/m in each month of Q4, even while the PMI index for manufacturing flatlined around 50. It is possible that the unweighted PMI is not capturing growth at larger firms.
Consumption growth remained robust. Retail sales growth accelerated to 18.1% y/y in December in nominal terms (from 17.3% in November), and to 13.8% y/y in real terms (12.8% prior). The urban household survey found disposable incomes up 9.1% y/y in real terms in Q4, compared to 7.1% y/y in Q1. Household spending also accelerated to 7.6% y/y in Q4, from 6.2% in Q3 and 5.5% in Q2 (see Chart 2). If accurate, these numbers indicate that the negative effects of inflation are fading and that China’s consumers are continuing to spend. One multinational client we spoke to recently, who sells clothes across China, also saw no signs of a slowdown. But other domestic retailers, both high- and low-end, reported an obvious slowdown in sales in Q4-2011, which they feared would continue into Q1-2012.
Upward wage pressure looks set to continue in 2012, though not to the same extent as in 2011. We expect manufacturing wages to rise another 10% on average this year; this, along with our forecast of 2% CPI inflation for 2012, will mean households should continue to benefit from real income growth.
Here are the specific "growth proxies" which Standard Chartered tracks:
Freight traffic: Pretty solid
The advantage of looking at freight traffic is that there is little reason to fake the data. The disadvantage is that, unlike GDP, it is not a value-added measure. The air freight market has collapsed, but it is a volatile business. Other freight sectors suggest much more stable growth through November 2011, as Chart 4 shows. Carriage of goods on roads is particularly important, and it grew a robust 20% y/y in October-November 2011.
Energy production: Softening a bit
Electricity growth is soft, as Chart 5 shows, suggesting that IP growth will also weaken in the coming months.
Air travel: Below average but steady
Domestic air travel, measured in person trips, is running at around 10% y/y and has even strengthened a bit in recent months. Chart 6 shows the varying fates of the Chinese, Asian and global economies in the last few years. International arrivals to China cratered during the global financial crisis and dipped sharply in early 2011. Regional arrivals, from Hong Kong for instance, also weakened more than local travel during the crisis and have been fairly steady in recent months. Local air travel did not decline as sharply as international or regional travel in 2008-09, and has glided to a below-average but steady path.
Cement and steel: Weakening, in line with FAI
Proxies for infrastructure and property are weaker, reflecting the slowdown in FAI growth. As Chart 7 shows, crude steel production growth hit 0% y/y in November, though it seems to have bounced back a little in December. Cement production growth is weakening too, and is running below the 12% average rate of the last decade.
[15]
That said, not everything is good: as has been long telegraphed, China real estate is crashing. But for now, it is still a slow motion collapse. And with inflation still hot in most non-residential sectors, China risks being exposed to the same monetary "intervention" that happened in the US in the past 18 months, which did nothing for housing, yet managed to get food prices in the US and around the world to quite revolutionary levels. Naturally, China differs from the US in two key aspects: food inflation there is real, without hedonic adjustments, and comprises over 30% of the CPI basket, unlike just 7% in the US [16]; and there is no social safety net, and thus the opportunity cost for people to get violently angry is far less than in the US where everyone is an involuntary member of the pension/retirement/401(k) and thus stock market ponzi.
On the property sector:
The correction has begun. Residential housing investment hit a 30-month low of 10.8% y/y in December (19.6% y/y in Q4), compared to 35.7% in the first three quarters of 2011. Floor space under construction fell 25% y/y in December (Chart 8 shows the 3-month moving average, which softens the decline); this suggests that investment in this sector has much further to contract.
Sales volumes declined substantially in Q4. Residential floor space sold fell 8.4% y/y in December (following average growth of 12.9% in Q3-2011). Completed residential floor space is still growing, up 9.3% y/y in December. This is resulting in rising apartment inventories. Expectations of price rises in Tier 1-3 cities appear to be reversing, and developers have been cutting prices since October in an attempt to shift inventory.
Prices will likely continue to fall. In Q2-2012, we expect the central government to begin signalling a policy shift to stabilise the sector. At the March National People’s Congress meetings, local officials will be lobbying aggressively for relief. Once prices have come down, we expect Beijing to start gradually easing some of the property market restrictions imposed in the past year in order to encourage first-time buyers into the market. This sector, though, remains the biggest risk to China’s economy.
What does all this mean from the PBOC's perspective.
If anything, today’s data is another reason not to expect a quick move to further loosening (see On the Ground, 11 January 2011, ‘China – China is loosening, but there is really no rush’). The economy is slowing, but not dramatically – so far.
The failure of the expected required reserve ratio (RRR) cut to materialise before the Lunar New Year is a disappointment (there are four more working days to go before the markets close). The People’s Bank of China (PBoC) instead engaged in an open reverse repo transaction with banks today in order to provide liquidity before the holiday – and there are reports of at least two other liquidity-providing actions between the central bank and large local banks. Liquidity is tight, but the PBoC has been actively managing liquidity, and we do not expect it to get tighter. Deposits should come back into the banks after the holiday, which will boost interbank liquidity, so we might have to wait a while for the next RRR cut.
And if not now, then when? Those hoping for an imminent response from the PBOC will be disappointed.
We look for more ‘interesting times’ ahead – and 6% q/q SAAR GDP growth. Under these circumstances, more monetary loosening will come, but only slowly. We still look for Q1 to be the bottom of growth momentum – but these numbers, though strong, raise the possibility that the coming slowdown will push into Q2 as well.
So is it time for a timeout on the race to the inflationary bottom, at least from the Chinese perspective?