China – En­ter­ing Q2 Good Mo­men­tum

China's Foreign Trade (English) - - Economy - By Kelvin Lau , Shuang Ding

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.

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