China – Entering Q2 Good Momentum
March PMIS surprised to the upside
China’s manufacturing PMI rose to 51.8 in March, the highest since April 2012, from 51.6 in February. The strong print confirms that manufacturing activity has picked up momentum since the Lunar New Year holiday. It also suggests that the economy is handling the recent de facto interest rate hikes well. Interestingly, much of the PMI improvement this time is from small enterprises – their sub-index jumped to 48.6 from 46.4 prior and an average of 47.1 in 2016. This is in line with our China SME Index, which improved to 60.0 in March, a 22- month high, from 56.3 in February. PMIS for large manufacturers, in contrast, remained steady at elevated levels (53.3). Also encouraging is the surge in the non-manufacturing PMI to 55.1 in March from 54.2 in February, as services now account for over 50% of the economy and nearly 4ppt of annual GDP growth. The improvement is also a relief in view of the slowdown in sales of cars and residential properties YTD.
A breakdown of the manufacturing PMI sheds light on upcoming March data. In particular, the rise in the ‘new export orders’ sub-index for a third straight month bodes well for a likely pick-up in export growth to 5.0% y/y from 4.0% in January-february. We forecast a narrow trade surplus in March, which could start widening again in Q2. Stronger “new orders” reflect rising demand, not just from external but also domestic markets. Although we see a dip in industrial production growth in March due to a high base effect, average growth of 6.1% in Q1 is still consistent with a steady Q1 GDP growth rate of 6.8% y/y. The fall in the ‘ input prices’ PMI sub-index echoes our call for PPI inflation to ease to 7.0% y/y from 7.8% prior, while CPI inflation probably dipped to 0.7% y/y on weaker food prices. We expect new loan growth to have rebounded to CNY 1,350bn, while M2 growth stayed modest at 11.2% y/y. FX reserves likely rose to
Figure 1: China – Key March data forecasts Chartered Research
USD 3.015tn by end-march thanks to a favourable FX valuation effect and tight capital controls.
FX reserves likely rose again in March
We expect FX reserves to have risen to USD 3.015tn by end-march from USD 3.005tn in February. This would be the second straight monthly increase, largely boosted by the favourable FX valuation effect. The USD weakened against the euro, the Japanese yen and the British pound over the course of March; this likely added around USD 19bn to headline FX reserves. The positive impact of the FX valuation change should have more than offset the drawdown in reserves (a modest USD 9bn, in our view, thanks to the recent stabilisation in currency expectations and stricter enforcement of capital controls). Increased scrutiny of outward direct investment and cross-border lending, together with renewed appetite for overseas borrowing, should have also helped headline reserves, despite an expected narrow trade surplus.
Trade balance likely in surplus, albeit a narrow one
Export growth should have ris- en to 5.0% y/y from 4.0% in the first two months of 2017, in our view. The improvement is likely supported by a favourable base effect and possibly higher prices. Export volume could have also picked up on prior Chinese yuan (CNY) weakness. This is in line with recent strength in the ‘new export orders’ sub-index of the PMI – it rose for a third straight month to 51.0 in March, the highest since April 2012, from 50.8 in February. We forecast c.7% export growth for 2017 amid improving demand from advanced economies.
We see imports rising 23.0% y/ y after a strong January and February (26.4%), also boosted by higher import prices. All this should have translated into a trade surplus of USD 2.7bn, a marginal improvement from a deficit of USD 9.15bn in February after recording USD 40bn+ monthly surpluses in the previous nine months (May 2016-January 2017). It has historically not been unusual for China to report much narrower trade surpluses for the month or two immediately after the Lunar New Year. The easing of the “imports” sub-index of the manufacturing PMI in March (to 50.5 from 51.2) also bodes well for the gap between import and ex-
Export volume could have also picked up on prior Chinese yuan ( CNY) weakness.
port growth to narrow in the coming months, leading to a likely wider trade surplus again.
Downside risks to March CPI and PPI inflation
Food prices fell at a faster pace m/m in March, according to official interim data. In particular, vegetable and egg prices have been dropping more sharply recently, while m/m changes in prices of fresh fruit and aquatic products have swung from positive to negative territory. Last year’s high base effect means the y/ y fall in food prices could be even steeper than the 4.3% drop in February, dragging overall CPI growth down to 0.7% y/ y from 0.8% prior, while non-food prices likely stayed flat m/m in March.
We expect PPI inflation of 7.0% y/ y in March, down from 7.8% in February. We see a likely m/m contraction (- 0.2%) for the first time in eight months. For example, prices of non-ferrous metals, and petrochemical and agricultural products have fallen over the past month, offsetting higher ferrous metal and construction material prices. The drop in the ‘ input prices’ sub-index of the March PMI (to 59.3 from 64.2) echoes this view. While we still expect commodity prices to be generally well supported throughout 2017, the lift from temporary production cutbacks is bound to fade, while underlying overcapacity challenges remain. More importantly, the prevailing favourable base effect on the PPI is likely to start normalising, especially in the latter half of the year. PPI inflation may have peaked cyclically at 7.8% y/ y in February. Easing PPI inflation and higher interest rates likely mean no runaway increase in CPI inflation in 2017, in our view.
Limited upside to credit and M2 growth for now
New Chinese yuan (CNY) loans likely rebounded in March following a post-holiday dip in February. We expect loans to have grown by CNY 1,350bn, up from CNY 1,170bn in February, but to have fallen short of CNY 1,370bn in March last year. Implied new loan growth should therefore have eased to 12.8% y/ y from 13.0% in February. We see a risk that loan growth will slow further this year as the authorities control the pace of credit growth. Much of the credit creation to corporates in March was probably infrastructure-related, while short-term corporate loans and bill financing still appeared prone to a squeeze. The m/m change in personal home mortgages is also likely to be of
New Chinese yuan (CNY) loans likely rebounded in March following a postholiday dip in February.
interest: a weak reading could reflect the effectiveness of policy guidance to deflate property bubbles in top-tier cities.
We expect total social financing ( TSF) to have increased by CNY 1,930bn, boosted by stronger bank loans and a potential rebound in offbalance- sheet financing. Corporate bond activity, however, likely remained subdued in March given the continued market sell-off amid rising interest rates. This implies 12.4% y/ y growth in outstanding TSF, down from 12.8% in January and February. We expect TSF growth to remain on the slow side this year on deleveraging in the financial market and tighter controls on broad credit. For the same reason, we see M2 growth staying low at 11.2% y/y, only a tad higher than February’s 11.1%, which was hurt by the People’s Bank of China (PBOC) draining liquidity via open- market operations ( OMOS) after the Lunar New Year. We see much less net OMO drainage in March than in February.
Growth indicators consistent with steady Q1 GDP growth
Fixed asset investment ( FAI) likely grew 8.6% y/y in March, down from 8.9% in January-february, dragging the Q1 average down to 8.7%. However, this is still stronger than 8.1% growth in 2016. Cooling sales and limited land supply in big cities may continue to pose downside risks to property investment this year. We expect infrastructure investment to keep propping up overall FAI growth, as in recent months, consistent with still-resilient growth in medium- to long- term corporate loans. Retail sales growth also likely rebounded in March after a disappointing start to the year, even though what ailed it in the first place has not really gone away. We expect car sales growth to remain low for longer, now that last year’s tax incentives have expired, capping retail sales growth on the upside. We expect retail sales to have grown 9.8% y/y in March, versus 9.5% in February.
Industrial production growth likely eased to 5.8% y/ y in March from 6.3% in January- February, mostly dragged down by last year’s high base. Our forecast still translates into 6.1% y/ y growth in Q1, consistent with the averages for Q3and Q4-2016. The steady production picture echoes manufacturing PMI data: the ‘output’ sub-index rose to 54.2 in March and averaged 53.6 in Q1, compared with 53.3 in December, suggesting a quick return of (if not outright stronger) production momentum after the holiday. And given the close correlation between industrial production and GDP growth, we are comfortable keeping our Q1 GDP forecast at 6.8% y/y, the same as in Q4-2016. However, we expect GDP growth to average a more modest 6.6% in 2017 as China prioritises economic and financial stability ahead of the 19th Party Congress in Q4. A resilient services sector, the end of China’s destocking cycle and an improving global backdrop are conducive to an optimistic real-activity outlook for the near term, but potential headwinds like cooling property investment and rising Us-china trade friction could soften GDP growth somewhat in H2-2017.
Industrial production growth likely eased to 5.8% y/ y in March from 6.3% in January-february, mostly dragged down by last year’s high base.