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China economic outlook

The Sun is About to Rise on China

For China-watchers, the first half of March is always exciting. It starts with National People’s Congress, during which the government announces its’ economic targets. After that, we get the picture for the first two months of the year, as January-February figures for industrial production, retail sales and fixed asset investment are released. We want to analyze these, with other economic data as a whole. However, before we move on, we want to emphasize that most of the Chinese economic data for the first two months of the year could be misleading, due to distortion effects of the Chinese New Year holiday. 

The growth target for 2017, pronounced as ‘6,5% and higher if possible’, sets the tone for 2017 policies. The government also have increased its’ budget deficit target. This means, the fiscal stimulus will support economic growth to reach governments’ target, in the year of the key Communist Party Meeting. However, the economy might not need heavy stimulus, if the positive trend in the first two months of 2017 continues. On the other hand, lower in M2 money supply growth target means tighter monetary policy, as we have seen recently. 

Almost all economic data for the first two months of 2017 painted a better picture for Chinese economy, except year-on-year growth in retail sales, which was 1,4 % points lower than December 2016 figure. However we don’t put much importance in this unexpected slowdown, since we think it was partly due to the sharp decrease in inflation, as retail sales are announced in nominal terms. 

Moving on to inflation, the fast increase in producer prices during Febduary, was mostly due to base effect (6,4 points of 7,8% yoy), which will gradually vanish in the coming months. Nevertheless, we start to observe that the firms were starting reflect higher costs in their prices. That’s why, we mostly ignore the unexpected fall of consumer inflation, as it is at odds with the strongly correlated PPI’s “Consumption goods” sub-item. The official explanation is ‘cold weather and lower food prices’, but we simply think the Lunar New Year struck again, until we see the inflation figures for March. 

When we wrote about our 2017 expectations, we have argued that the positive surprise in terms of growth would come from private investment. However, the speed it arrives is beating our expectations so far, led by property investment. The recovery in private investment and economic activity would support growth and lead to a wider space for policy makers, enabling them to focus on risk control and structural reforms. 

Looking at external indicators, the eye-popping growth in imports was cheered around the world, while exports have dissappointed. Once again, we remember the effects of Lunar New and, thus, prefer looking at smoothed data, which looks good. Meanwhile, the FX reserves have stopped falling in February, reflecting the effect of capital controls. 

Tying all together, we think the silver-lining in Chinese economic outlook is slowly turning into a sun-rise. Looking at all economic data as a whole, we think China will grow around 6,6-6,8%, in 2017. The improving outlook also confirms our view and opens the space for the People’s Bank of China to start rate hikes, sooner than our initial expectation. Depending on inflation outlook, we now expect the first rate hike anytime after mid-July, when second quarter GDP growth will be announced. Of course, if inflation stays under control, PBOC can opt for tightening liquidty conditions, as it did in early February.

December PMI’s Paint a Nice Picture…

The new year has started with a nice surprise for China, as Caixin Markit PMI data (private) handsomely beat expectations. Manufacturing PMI has recorded the biggest jump in almost four years, while the composite PMI, which aggregates manufacturing and service sectors has reached its’ highest level in the last 45 months. On the other hand, National Bureau of Statistics’ official PMIs has recorded marginal decreases for both sectors. We already know that official and private PMI data could move in opposite directions, for a given month. However, this can not hold the China PMI data back, from being quite succesful proxies for GDP growth.

Below, we can see that both PMI data points to a pick up in GDP growth data for the fourth quarter of 2016. However, we don’t think this pick up would go too far, particularly not as much as the private index suggests. That’s because it seems wise to be prudent, especially at a time which the global economy is flooded with uncertainties and risks. Moreover, we advise our readers against drawing conclusions about China, by looking at only one months’ outcome. Nevertheless, we can confidently say that GDP growth would increase a bit, compared to third quarter, and the governments’ target of 6,5%-7% growth for the whole year would be comfortably met.

Nowadays, anyone saying only positive words about China would not deemed credible. Thus, let’s see if there are negative details in the PMI. Both official and private PMI’s employment sub-indices suggest decreasing employment in manufacturing industry. Moreover, input prices seem to increasing steeper than PPI, which can be seen as an indication of manufacturers’ difficulties about reflecting higher costs in their prices. Since we expect the positive suprise of 2017 to come from private sector, we might follow this trend more closely in the coming months.