Credit Easing Boosts Chinese Growth in 1Q06
Apr 20, 2006
Denise Yam (Hong Kong) and Andy Xie (Hong Kong)
Summary & Conclusions
China’s economy expanded 10.2% YoY in real terms in 1Q06, in line with the significant pick-up in bank lending that prompted us to upgrade our GDP growth forecast for the year to 9.5% from 7.8% recently. Although economic activity indicators (industrial output, investment, retail sales) showed growth acceleration across the board, price indicators suggest limited inflationary pressure. This is sound evidence of overcapacity in a large number of sectors, resulting from excessive investment over the past few years, in our view. The latest statistical report squares with our view that the easing in bank lending, which we suspect is intended to support state bank IPOs and working capital liquidity at local property developers, is sustaining fixed investment growth. The availability of low-cost capital amid expectations of continuous currency appreciation makes this growth model seem sustainable. We expect growth to remain strong this year, but caution that further indulgence in the construction boom will leave China with more excess capacity and the risk of a harder landing in 2007-08. GDP Expanded 10.2% YoY in 1Q06 China’s economy expanded 10.2% YoY in real terms in 1Q06, in line with the significant pick-up in bank lending that prompted us to upgrade our GDP growth forecast for the year to 9.5% from 7.8% recently. Nominal GDP totaled Rmb4.33 trillion in 1Q06, up 14.1% YoY, implying a GDP deflator of 3.5% YoY (+3.8% in 2005). Growth Pick-up Across the Board Reversing the deceleration in 4Q05, economic activity, as measured by trade, industrial output, fixed asset investment and retail sales, showed an unambiguous pick-up in 1Q06. Trade data released earlier indicated strong momentum in IT exports. Exports grew 26.5% YoY in 1Q06 to US$197.2 billion, again outpacing the 24.9% gain in imports, resulting in a trade surplus of US$23.2 billion, up 41% YoY. The sharp jump in new loans of Rmb540.2 billion (+50% YoY) in March lifted urban fixed asset investment by 32.7% YoY to Rmb631.4 billion, the strongest gain since April 2004, when the government stepped up macro tightening measures. For 1Q06 as a whole, urban fixed investment totaled Rmb1.16 trillion, up 29.8%, accelerating from 25.3% in 1Q05 and 27.2% in 2005. Aggregating with the 18% gain in rural investment, total fixed investment totaled Rmb1.39 trillion, up 27.7% YoY (+22.8% in 1Q05 and +25.7% in 2005). Value-added industrial output also saw strengthening momentum. Growth accelerated to 17.8% YoY in March, the strongest rise since April 2004 (excluding months affected by the Lunar New Year effect), bringing 1Q06 total output to Rmb1.78 trillion, up 16.7% YoY (+16.4% in 4Q). Sectors that saw above-average output growth were metals (+22-45%), IT products (+22-57%) and autos (+36%, sedans +71%). Retail sales growth also picked up in March to 13.5% YoY, stronger than the 12.5% rise in January-February and 12.6% in 4Q05. A key policy initiative in the new 5-year plan is to improve income and wealth equality, social security and encourage consumption. While we agree that China will become a promising consumer market, we think this will only be realized several years from now. We believe that a portion of the current reported retail sales is in fact investment-related sales, such as construction and renovation materials, e.g., bathroom tiles, kitchen fittings etc., which have been boosted by the ongoing construction boom, and should not be interpreted as strong consumer demand. Overcapacity Caps Inflation Inflation data for March surprised on the downside. The CPI rose only 0.8% YoY, down from 1.4% in January-February. Retail inflation slipped to 0.2% YoY in March, from 0.7% in the first two months. The producer price index gained 2.5% YoY, down from 3.1% in January-February. These price gains are the mildest since 2H03. For 1Q06 as a whole, CPI, RPI and PPI inflation averaged 1.2%, 0.5% and 2.9%, respectively. The biggest drivers of consumer inflation continue to be food (+1.9% YoY in 1Q, contributing 0.6 percentage points) and residence costs (primarily housing rent and utilities; +5%, contributing 0.7 ppts). Upward pressure from these components meets with deflationary pressure from clothing and durable consumer goods. We continue to expect price reforms to lift overall inflation this year, although pressures from overcapacity appear to be increasing. More Growth, More Capacity, Harder Landing We recently upgraded our GDP growth forecast for China this year to 9.5%, from 7.8% originally, primarily in response to what we interpret as an intentional easing in financial policy and the associated acceleration in bank lending (see Stronger Economy, Riskier Landing, April 18, 2006). We now see easier credit sustaining fixed capital formation expenditure growth at 18% in the year, up from 13% originally. We remain convinced that China needs a change in its development model, which has been based on the government mobilizing resources to increase capital formation, which in turn fuels export growth. Sustained strong growth in exports and loan-driven investment in the recent months are worsening China’s imbalances. The availability of low-cost capital amid the expectation of continuous currency appreciation makes the current growth model seem sustainable. Growth is expected to remain strong this year, but we caution that further indulgence in the construction boom will leave China with more excess capacity and the risk of a harder landing in 2007-08.
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