International | Nov 19 2010
GaveKal offered the following China observations this week:
China's tightening process has now undeniably begun. The reason for the recent hikes in interest rates and required reserve ratios became obvious with last week's inflation report: CPI in October accelerated +8.4% on an annualized MoM basis, after an already-worrying +7.2% MoM leap in September. And although the biggest contributor to the upside surprise was food prices (+10.1% YoY vs +8% in September), both producer price indices for industrial goods and raw materials also rebounded in October, reversing the trend of the prior four months. As the NDRC pointed out, the causes of China's inflation are not all linked to food: "expansionary monetary policy and rising wages also played a role" (see Asia's Paradigm Shift, Looking for the US Corporate Earnings Trifecta).
This pick-up in inflation undeniably clouds the outlook for Chinese policy. In recent months, we have argued repeatedly that because of the political calendar and economic turning points, the important reforms that China needs to embrace (fiscal reform, financial reform and service sector deregulation) should occur between now and the end of 2012. However, all of a sudden, the risk is growing that these important reforms get sidelined and that policymakers end up making a step backward by concentrating on fruitless 'price control' measures (including food and fuel prices under draft plans announced yesterday-see article here). Needless to say, we are firm believers that keeping prices in check will require tighter monetary policy and so we fully expect further RRR and interest-rate hikes through 1H11, and tighter bank credit quotas in 2011. In recent past inflationary upturns, RMB appreciation has also been used as an tool to fight imported inflation. These developments go hand in hand with our belief that China is abandoning The Wen Jiabao Put (i.e., the guarantee that growth will not dip below +8%).
In turn, this poses an immediate question on Chinese property: real estate investment (up +37% YoY) and floor space under construction (up +23%) both accelerated in October over September, but we fully expect such numbers to head back down in the coming months. The combined commercial and housing property sales volume (-11% MoM) and value (-8% MoM) both fell in October on the previous month, already reflecting the impact of restrictive measures implemented at the end of September. On an annualized MoM basis, house prices fell -2.4% in October, down from +6% in September. We expect both prices and sales to decline further. And this is important because a cooling property market means a higher risk of developer defaults. Indeed, according to the China Banking and Regulatory Commission, 92% of loans held by real estate developers are due for repayment by end 2012 (28% will mature in 2011 and 64% in 2012). So with the fight against inflation, tighter credit quotas in 2011 will make it harder for banks to roll over loans just as the potential for developer cash flows to shrink because of a slowdown in sales volumes increases… And this brings us back to one of our current themes, namely the fact that China's ability to take some pain on the real estate sector will be a true gauge of its willingness to embrace reform (see Housing as a Gauge of China's Structural Reforms). Another key theme is that there have been two drivers to the recent rally in Chinese, and Asian equity markets: a) the hope for stronger earnings (this has boosted Chinese consumption stocks, regional pharmas, etc…) and b) the hope for massive asset reflation (HK property, shipping, etc…).
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
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