China Watch – Growth peaks in Q1

by: Arjen van Dijkhuizen

  • Growth picks up further, to 6.9% yoy in Q1; ‘upside risks’ to 2017 forecast
  • Still, gradual slowdown to resume, longer-term risks remain
  • Imports and export growth shows a clear rebound
  • Risk of a full-blown, damaging trade war has fallen
  • US has not labelled China a ‘currency manipulator’
  • FX reserves rise for second month, as capital outflows abate and even reverse
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Real GDP growth picks up further in Q1 …

China’s recent macro data surprised to the upside. Annual growth picked up further in Q1, reaching a six-quarter high of 6.9% yoy. This was higher than the consensus and our expectation of 6.8% yoy. Growth was supported by stronger momentum in global growth and trade and by previous stimulus, while the property sector has been quite resilient to targeted tightening measures. Helped by reflationary trends, nominal growth even jumped to a five-year high of almost 12%. The pick-up in growth was mainly driven by the industry and construction sectors, for which growth rose from 6.1% in Q4-2016 to 6.4% in Q1-2017. The services sector remains the fastest growing, although growth slowed from 8.3% to 7.7%. Bloomberg’s monthly GDP estimate rose to 7.1% yoy in Q1, with the March number jumping to a four-year high of 7.6% yoy. Our baseline view is that growth has peaked in Q1 and is likely to resume a gradual slowdown in the course of this year, although ‘upside risks’ to our 6.5% growth forecast have risen. With growth in Q1 clearly above the 2017 target of ‘around 6.5%’, the authorities have more leeway to continue with leaning against the wind by means of a moderate, targeted tightening policy.

  

… with March data generally showing improvement

Macro data for March were generally strong. Industrial production jumped to 7.6% yoy, the highest growth rate since December 2014. Fixed investment rose to a 10-month high of 9.2% yoy in March, with the divergence between growth of private and state-led investment falling further. Retail sales growth rose back to 10.9% yoy, equaling the 2016 peak reached in December. Meanwhile, the purchasing managers’ indices (PMIs) for March published in early April showed a rather mixed picture. The ‘official’ manufacturing PMI published by NBS rose to a five-year high of 51.8, and NBS’s non-manufacturing PMI rose by almost a full point to 55.1, the highest level since May 2014. However, Caixin’s manufacturing PMI fell back to 51.2 (February: 51.7), while Caixin’s services PMI dropped to 52.2 (February: 52.6). The NBS PMI survey has a stronger focus on the larger SOEs, while Caixin’s survey better captures the medium-sized and smaller enterprises.

  

Imports and export growth shows a clear rebound in Q1

The recovery of Chinese exports and imports goes hand in hand with the firming momentum in global growth and trade. Chinese trade data are very volatile, particularly around Lunar New Year breaks, but if we look through seasonal and other distortions they show a strongly improving trend. In Q1-2017, goods imports rose by 24% yoy in USD terms. To a large extent, this strong number reflects base effects, as lower import prices (for instance for commodities) pushed imports sharply down in Q1-2016. Still, a firming of domestic demand and the uptick in global trade supporting processing trade is also playing a role. Import volumes of commodities look resilient, having recovered in March from the LNY-related dip in February. Import volume growth is still higher than real GDP growth for iron ore, copper ore and oil. Meanwhile, China’s goods exports in Q1 rose by 8% yoy in USD terms. This was partly explained by base effects including price effects, but also reflects firmer external demand and the weakening of the yuan supporting external competitiveness. Going forward, we expect import and export growth to slow gradually in yoy terms in the course of this year in comparison to the strong Q1 numbers.

Trade war risks have fallen as China has not been labelled ‘currency manipulator’

We think that the risk of a full-blown and damaging trade war between China and the US has clearly fallen, at least on the short term. First of all, the US has not yet labelled China a currency manipulator. Trump publicly stated last week he did not regard China a currency manipulator anymore (during his campaign he promised to do so on day one of his term). His changed tone also has a geopolitical background, as Trump wants China to increase pressure on North Korea (he openly tweeted on these issues). The Treasury’s bi-annual report published last Friday also confirmed that China was not classified as currency manipulator. Under the Treasury’s methodology, China does ‘comply’ to only one out of three criteria for being labelled as such (having a large bilateral surplus with the US). On the other two, (having a current account surplus > 3% of GDP and using one-way interventions to weaken the currency) it does not. Still, together with Japan, South Korea, Taiwan, Germany and Switzerland, China will remain on the Treasury’s watchlist and the US will continue to closely monitor China’s exchange rate policy.

  

… and Trump-Xi Jinping summit has resulted in 100-day trade plan

Previously, the meeting on 6-7 April between Trump and China’s president Xi Jinping in Palm Beach, Florida. did not result in a joint press communique, nor a joint news conference. However, the general impression was that the meeting functioned as a mechanism to smoothen relations. The US and China for instance agreed on a 100-day plan for trade deals. This plan should help the US to reduce its large trade deficit with China (almost USD 350bn in 2016). China reportedly is going to relax certain restrictions on imports of US beef and energy, while also relaxing rules on US financial services investment in China. These plans also help to lower the risk of a damaging trade war.

FX reserves rise for second month, as capital outflows abate and even reverse

In March, China’s FX reserves rose for the second consecutive month, climbing by USD 4bn to USD 3009bn following a USD 7bn rise in February. Although currency valuation effects still play a role, the main message is that FX reserves have stopped falling. This suggests that the PBoC’s tightening of capital outflows, its measures to drive market rates higher and its policy to stabilise the USD-CNY rate (with the CNY having appreciated around 6% versus USD so far this year) have been effective in reining in capital outflows. According to Bloomberg, China even saw net capital inflows of almost USD 24 bn in February, for the first time since January 2015. Looking forward, we cannot exclude that periods with rising outflows will return, for instance related to the Fed rate hike cycle. However, we continue to expect that the authorities will remain able to keep control and prevent a massive CNY depreciation versus USD. Measures taken to support capital inflows (e.g. opening onshore FX derivative markets to foreign investors, gradual opening interbank bond market) will also help keeping net outflows in check.

  

Producer price inflation eases but remains high; food prices keep CPI low …

Producer price inflation has risen sharply over the past half year, driven by the past upward correction of commodity prices, cuts in overcapacity, a weaker yuan and firmer domestic demand. Still, PPI eased somewhat in March, to 7.6% (February: 7.8%). As strong base effects are fading, we think PPI inflation has peaked and will gradually fall in the course of this year. Headline inflation remained low at 0.9% yoy, driven by falling food prices (-4.4% yoy), with non-food inflation rising slightly to 2.3% yoy. We still expect higher PPI inflation to trickle down to some extent into higher CPI inflation in the course of this year. However, as the impact of falling food prices is expected to stay for some time given base effects, we have lowered our 2017 inflation forecast from 2.5% to 2%. Meanwhile, core inflation edged up again to 2% yoy (February: 1.8%), but remained reasonably low as well.

… but PBoC is likely to continue with moderate tightening policies

Despite the fact that inflation is still clearly below the 3% target, the PBoC has stepped up its moderate, targeted tightening policy, for instance by hiking interest rates on its open market and lending facilities. This is primarily triggered by concerns over excess financial leverage and the potential build-up of asset bubbles, but inflation, currency considerations and external factors (Fed rate hike cycle) also play a role. The PBoC is out to get ‘risky’, heavily levered market participants and to contain shadow banking, while also aiming to cool overall credit growth. There are some signs that that is starting to work. Still, the PBoC does not aim to aggressively pull the monetary brakes. This is also illustrated by the fact that the PBoC continues with adding liquidity to the banking system if circumstances ask for that. All in all, we expect the PBoC to continue with its cautious tightening policies while for the time being refraining from hiking the benchmark one-year lending rate.

To conclude

Growth in Q1 has clearly been above the 2017 target of ‘around 6.5%’, and we see ‘upside risks’ to our 2017 forecast of 6.5%. This means that Beijing has more leeway to focus on longer-term financial stability risks and continue with leaning against the wind. Still, in this politically important year, we do not expect Beijing to tighten aggressively and tolerate a sharp slowdown. All in all, we expect growth to have peaked in Q1 and China’s gradual slowdown to resume in the coming quarters. Longer term, risks surrounding this outlook still stem from high and still rising debt levels, from the lengthy transition and from external factors, although the risk of a damaging trade war with the US has clearly fallen.