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Theme: Top 7 FAQ on Chinas slowdown. Weve been bombarded with many questions on the anatomy of Chinas slowdown and what it means for the rest of the world after the surprise contraction in Januarys Markit PMI. Here are the top 7 questions and our responses. 1) 2) 3) 4) 5) 6) 7) Can we write off the weak PMI as a Lunar New Year effect? What is the current state of the Chinese economy and the outlook? What does the slowdown in China mean to the world? What does the slowdown in China mean to the developed world? Whats the impact on emerging markets? What is the latest on Chinas debt problem? How do you invest in this environment?
Macroeconomic and market charts: Besides the PMI, what stands out this month is the slowdown in house price appreciation (Chart 16). House prices were rising 1%MoM for most of 2013 but in November and December, the pace has halved to 0.5%MoM. The minor property tightening measures introduced in October are working. Therefore, we expect construction activity and domestic demand to weaken in 1H 2014.
Tidbit: We often hear about the severe pollution in China and the pollution is now impacting agriculture output. A government official has stated that more than eight million acres of Chinas farmland is too polluted with heavy metals and other chemicals to use for growing food. Pollution has now implications for Chinas food security policy and may get more attention over the next several years. Reducing metal pollution was included in the latest five year plan but so far little has been done. Furthermore, pollution problem worsens over the Lunar New Year since fireworks are often used and increase particle levels.
You can also find our research materials at our website: www.mb.seb.se. This report is produced by Skandinaviska Enskilda Banken AB (publ) for institutional investors only. Information and opinions contained within this document are given in good faith and are based on sources believed to be reliable, we do not represent that they are accurate or complete. No liability is accepted for any director consequential loss resulting from reliance on this document. Changes may be made to opinions or information contained herein without notice.
China Tracker
1) Can w e w rite off the w eak PMI as a Lunar New Year effect?
We should be very cautious about extrapolating Chinas growth based on January and February data. The two China PMI series are seasonally adjusted but the statistical models are still not good enough to adjust for the movements of the moon. Chart 1 shows the average and median month over month change in the national PMI since 2005. January and February are typically weak followed by a big boost in March, when we get a full and clean reading post the Lunar New Year. Often, Marchs rebound is large enough to compensate for the downturn in January and February and market worries disappear. The economy will slow in 2014 but not like the pace we saw in January PMI.
Chart 1: China National PMI seasonality
7 6 5 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 PMI seasonality % MoM since 2005
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2) What is the current state of the Chinese economy and the outlook?
Chinas economy has two engines, exports and domestic demand and the charts in the Macroeconomic Tracker section below will help us explain the developments. Domestic demand has been strong as you can see from Chart 13 where construction activity has been accelerating. However, going forward domestic demand and construction activity is likely to slow since monetary policy has tightened in 4Q (Chart 23) and the pace of increase in property prices have slowed (Chart 16). We are not so concerned about the slowdown in domestic demand since this is a consensus, long term, structural view and authorities can always restart this engine by loosening monetary policy since inflation is low and likely to fall. The bigger concern is the export engine. As Chart 11 shows, exports have been recovering from improved demand in US and Europe. Exports are important for domestic demand as well since they generate income for households who consume and for businesses to invest. The recent PMI data has us and markets questioning the outlook on exports since export orders subcomponent has been weak and US ISM (manufacturers sentiment) has tumbled. Cold weather may explain the weak US demand and SEBs view is that the US economy remains healthy. However, downside risk to our China 2014 real GDP forecast of 7.4% has increased, especially since export slowdown is harder to tackle with Chinese policy adjustment. China can delay currency appreciation to support exports but that has negative consequences abroad (e.g. trade tensions). In addition, exports in Asian economies are much more influenced by volume changes rather than currency adjustments.
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Source: CEIC, Macrobonds, SEB; real GDP data is from World Bank, WDI USD at constant 2000 prices
4) What does the slow dow n in China mean to the developed w orld?
Not much is the answer again looking at it from the causality angle. For example, if we look at the US, exports to China are less than 1% of US GDP (Chart 3). Slowdown in Chinas demand wont hurt US exports and the US economy. Even for EU, exports to China are just 1.7% of GDP and will have limited impact. Where we are more concerned is that the slowdown in China and weak PMI are signaling weaker developed market growth ahead. Chinas national PMI for January slowed to 50.5 from 51.0 but the export order component is slowing and have been below 50 for two months in a row (below 50 means contraction). Chinese manufacturers dont believe that the US economy is as strong as the Federal Reserve expects. Our US bearish clients remind us that a) good news on US economy is already priced in where Citi US economic surprise index are at the peaks and heading lower and b) high inventory in the US will be a drag on growth (Chart 4). The movement in financial markets are also pointing to possible weaker growth where the market sell-off in EM is pushing US 10 year yield lower. China wont cause the developed world to slow but China may be a barometer of developed markets growth outlook.
Chart 3: Exports to China as % of GDP is small for DM
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Chart 5 shows that China provides about half of the growth in emerging markets (green bars) and for BRICS (Chart 6), China contributes to two-thirds of the growth. Just on sheer size, Chinas economy is now US$9trn whereas Brazil is the next largest BRICS economy at just 25% of the size at US$2.3trn. At the country level, we look back at Chart 3 above and it shows emerging Asia to be the most reliant on Chinese demand led by Taiwan, Malaysia, Korea and Thailand followed by specific commodity exporting economies such as South Africa and Chile. Of the big EM economies, Turkey is the safe haven from a China slowdown.
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Source: CEIC, Macrobonds, SEB; CEIC, Macrobonds, SEB; real GDP data is from World Bank, WDI USD at constant 2000 prices
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China Tracker
This doesnt mean that you should ignore Chinas debt problem. The biggest and immediate implication of high debt is a slower growth rate. Debt by definition brings growth and consumption forward by borrowing from future income. This is the main reason why our China forecast declines into 2015 to 7.0% despite a more aggressive US growth forecast that accelerates to 3.7% in 2015.
Chart 7: Debt as % of GDP
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China Tracker
MACROECONOMIC TRACKER
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Chart 11: Exports are rebounding from improved demand from US and Europe but it is still moderate. Demand from Asia is weak from over-billing in 2013.
Chart 12: PMI has declined, especially in Markit PMI that has less exposure to large companies. Markets react to Chinas PMI but looking at the chart, we dont see how it helps you forecast, except may be exports. In addition, some commentators say that the new order sub index is a leading indicator but we dont see the evidence.
% yoy 3mma
Chart 13: This is our favourite indicator of domestic demand and points to strength. Targeted policy easing in infrastructure projects and healthy house prices has helped. However, going forward, tighter monetary policy and slightly weaker house price increases will slow the pace in construction activity.
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Chart 14: Consumption - vehicle sales have gained momentum after a slowdown from the anti-corruption campaign.
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China Tracker
Chart 15: Hot money inflows are slowing and put less pressure for CNY to appreciate. The chart below is 3 month moving average but in December outflow started.
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Chart 16: Average property prices continue to rise and likely helping the rebound in construction activity. However, the pace of increase is slowing from approximately 1%MoM to 0.5% from property measures reinstated in first tier cities.
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2.0 RMB trn 3mma New Total Financing New Bank Lending 1.5 1.0
Chart 17: Crackdown in total social financing (bank and non-bank lending) and recent rise in interbank rates had tightened monetary conditions. With inflation low, monetary conditions can be loosened if growth decelerates faster than expected.
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Chart 18: Inflation has peaked and decline in pork prices signal very little inflation pressure. We are forecasting CPI to be 3.1% in 2014.
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China Tracker
MARKETS TRACKER
6.40 6.35 6.30 6.25 6.20 6.15 6.10 6.05 6.00 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 USDCNH spot USDCNY fixing USDCNY spot
Chart 19: Stabilization in exports, reluctance to intervene and accumulate more FX reserves and return of hot money inflow will push USDCNY lower. Our 2013 year-end target is 6.08 and 5.90 for end 2014.
Chart 20: Seasonality is difficult to see in USDCNY since it has been a one way bet. However, we focus on the changes relative to the month before and February usually leads to a flat or slightly strong fixing. We are short USDCNY I month NDF in our Asia FX Portfolio but we are aware that the short term drivers are slowly fading.
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Chart 21: USDCNY spot has been able to fully use the daily allowed +/- 1% band. The movement lower in USDCNY fixing has now started to impact spot to come off the bottom of the band. We also expect a widening of this trading band to +/- 1.5% or 2% in the coming quarters.
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Chart 22: Recent move lower in fixing is flattening the front end of the forward curve. It is better to short USD/CNY in the 6-12 months part of the curve currently.
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China Tracker
MARKETS TRACKER
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Chart 23: Liquidity conditions are easing after a spike in January but we expect it to settle closer to 4% than 3% previously.
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Chart 24: The CNH bond performance is recovering after a general global bond market sell-off from the rise in US yields. Move lower in USD/CNY fixing will keep CNH and the bond market stable.
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Chart 25: CNH deposits in Hong Kong have been rising and can continue to rise with a stronger move in CNY.
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Chart 26: Domestic equity market had been underperforming the US S&P market. Higher rates have not helped and IPO pipeline is large and limits upside. Looser monetary policy will be a catalyst to get equity markets higher.
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China Tracker
FORECASTS
FX USD/CNY USD/CNH USD/HKD USD/IDR USD/INR USD/KRW USD/MYR USD/PHP USD/SGD USD/THB USD/TWD EUR/USD USD/JPY EUR/SEK EUR/NOK AUD/USD Policy Rates CH lending CH deposit Korea India Indonesia Malaysia Philippines Thailand Taiwan US EU SW NO AU Spot 6.06 6.03 7.76 12,194 62.6 1075 3.31 45.3 1.27 32.8 30.3 1.35 102 8.83 8.43 0.90 Current 6.00 3.00 2.50 8.00 7.50 3.00 3.50 2.25 1.88 0.25 0.25 0.75 1.50 2.50 1Q 6.05 6.05 7.80 12,500 62.5 1090 3.35 45.5 1.30 34.0 30.5 1.34 105 8.85 8.35 0.88 1Q 6.00 3.00 2.50 8.25 8.00 3.00 3.75 1.75 1.88 0.25 0.25 0.75 1.50 2.50 2Q 6.02 6.02 7.80 12,200 61.5 1070 3.30 44.5 1.26 33.8 30.3 1.31 106 8.80 8.40 0.88 2Q 5.75 3.25 2.50 8.25 8.25 3.25 4.00 1.75 1.88 0.25 0.25 1.00 1.50 2.50 3Q 5.98 5.98 7.80 12,000 60.0 1050 3.20 44.0 1.24 33.5 29.4 1.30 108 8.65 8.45 0.87 3Q 5.75 3.25 2.75 8.25 8.25 3.50 4.00 1.75 1.88 0.25 0.25 1.00 1.75 2.50 4Q2014 5.90 5.90 7.80 11,500 59.0 1020 3.17 43.5 1.21 32.5 29.0 1.28 112 8.50 8.50 0.85 4Q2014 5.50 3.50 2.75 8.00 8.00 3.75 4.00 1.75 2.00 0.25 0.25 1.00 1.75 2.50
Real GDP % yoy China India Indonesia Korea Singapore US Euro zone Sweden Norway CPI % yoy China India WPI Indonesia Korea Singapore US Euro zone Sweden Norway
2011 9.3 7.5 6.5 3.6 5.3 1.8 1.6 3.7 1.2 2011 3.3 9.5 5.1 4.2 2.8 3.1 2.7 3.0 1.2
2012 7.7 5.4 6.2 2.0 1.3 2.8 -0.7 1.0 3.1 2012 3.5 6.5 4.3 1.4 4.5 2.1 2.5 0.9 0.8
2013 7.7 4.7 5.6 2.8 3.2 1.7 -0.4 0.7 0.9 2013 2.7 6.2 7.2 1.3 2.4 1.6 1.5 0.0 2.2
2014 7.4 5.0 5.3 3.6 4.0 3.3 0.8 2.5 2.4 2014 3.1 5.6 6.8 2.2 2.9 1.6 1.0 1.0 2.1
2015 7.0 5.4 5.5 3.5 3.8 3.7 1.6 3.2 2.1 2015 3.2 5.2 5.5 2.3 2.6 2.2 0.9 2.0 2.3
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China Tracker
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