Rudi's View | Jul 16 2010
By Rudi Filapek-Vandyck
This week's second quarter data releases in China fit in almost perfectly with the ruling trend for economic data most elsewhere: not only is economic momentum slowing down, it is slowing down faster than anticipated.
Even though most economists and China watchers try to highlight the positives, such as the benign inflation numbers, the opportunity for Chinese authorities to relax and the fact that first half GDP growth was still in double digits, few are able to not mention the fact that the rate of decline in yesterday's data was nevertheless faster than expected.
The end results are predictable but important to highlight nevertheless: growth expectations for the Chinese economy are being reduced by another notch here and there, while inflation projections are being lowered as well with the effect that forecasts for interest rate hikes are equally dropping.
Some economists maintain there could be one more interest rate hike, possibly in the final quarter this year, but many are now adopting the view it is probable there won't be any further tightening from the Chinese this year, not in terms of extra reserve requirements for banks, not in terms of interest rates and probably not in terms of further clampdowns on Chinese property speculation either.
With the exception of very bullish commentators, such as Chief Economist at CommSec, Craig James, most commentators have no difficulty acknowledging that the rate of decline in key areas of the Chinese economy such as industrial production is cause for some concern. Most worries, however, are being offset by the fact that inflation numbers for the June quarter equally proved below market expectations, and that is ultimately a good thing.
In China, consumer inflation is always closely linked to food prices but the few economists who have taken the effort to dig deeper into the details affirm my own primal thoughts on the matter: the benign CPI number in itself is another piece of evidence that heavy industry in China is going through a slowing down phase.
All in all, I think these Q2 data are likely to keep investors on edge for further evidence of slowing activity. This will especially be the case because of two key elements:
1.) the rate of decline has turned out faster than expected, raising questions about what will happen in the two quarters ahead
2.) it is heavy industry that is decelerating faster than expected; these are the companies that matter for bulk commodities and industrial metals
No wonder thus, more bearish inclined China watchers such as CLSA are forecasting ongoing declines in spot iron ore prices until well into 2011. Surely, for anyone with a bearish view on China and on the world in general, yesterday's data will have been welcomed as more confirmation that the world remains too bullish on what is happening inside the Middle Kingdom.
Following on from the bigger than expected drops in June China PMI surveys, yesterday's data seem ideally placed to explain why spot iron ore prices have been in free-fall since May, or why the Baltic Dry Index has halved over the period: China may not be heading for a hard landing, economic activity is slowing down at a pretty fast pace nevertheless.
A theme also touched upon by BA-Merrill Lynch strategist Tim Rocks today. Admittedly, Rocks is not exactly one of the more bullish market commentators in Australia, but investors might want to pay attention to his timely comments today.
The global investment community is only now coming to terms with what is really happening in China, argues Rocks, and that is the government is now actively discouraging private investment. Forget about all the rhetoric about sustainable growth et cetera, what this boils down to, says Rocks, is that overall demand for commodities from China will be less.
One primary example cited is the steel sector. According to the latest data released, Chinese steel production has now fallen to its lowest rate of growth since 2001. At 8.9% growth, Rocks points out steel growth is now below (non-adjusted) headline GDP growth.
Another reason why the Baltic Dry Index has collapsed since May (if you think “collapsed” is a bit too heavy of a word to use then consider the index has lost more than 50% in a few weeks time and is now down 34 days in a row).
Also, if you agree with Rocks it is not difficult to see why iron ore prices should remain under pressure for a while yet.
Wait a minute, I hear you all say, second quarter GDP growth only missed consensus expectations by 0.2% – hardly the kind of stuff that matches any of the above. As per usual, the devil is in the detail. China announced yesterday that first half annualised GDP growth was 11.1% which was right on cue with market consensus. But then it released a Q2 GDP growth figure of 10.3% only.
11.1% over six months matches 10.5% in Q2. The lower than expected growth figure for the June quarter suggests the corresponding number for the March quarter has been revised higher. Subtle change? It means that the rate of decline proved higher than was expected.
To put it in another way: one would hope the rate of decline over the next two quarters will be much slower, but we won't know for certain until the next set of data will be released. It is telling though that some media are today publishing calls from some experts that more support from the Chinese authorities will be needed later in the year.
I note the Chinese authorities last week announced a further RMB682 billion investment plan for 23 major new infrastructure projects. Such initiatives fit in with this week's slower than expected data.
Also, note that China publishes GDP growth data on year-on-year comparison only. Economists worldwide are thus having fun in re-calculating and guessing what actually has happened in between quarters, and without the seasonal disruptions.
On such seasonally adjusted calculations the Chinese economy seems to have grown around the 8% level in the June quarter (one economist put the figure as low as 7.2%), or below intrinsic capacity. If my observation is correct, more economists are now assuming GDP growth in China will end up closer to 8% by year end instead of the previously projected near 9%. That's on non-adjusted, as published data.
If correct, this will have lowered headline growth for the Chinese economy from 11.9% (non-corrected for the latest implied revision) to 8%, or close to 400 basis points. Even without hard landing scenarios, this is by anyone's standards quite a sizeable slow down. This week's data suggest we already have seen half of this slow down take place over the past three months.
Admittedly, there is a danger of interpreting the data too negatively. Economists at National Australia Bank, for instance, believe last year's Q2 numbers were artificially boosted by government stimulus making the slow down in this year's June quarter look bigger than it actual is.
Also, on their own calculations, adjusted, quarterly growth has only declined from 2.5% in Q1 to 2.3% in the June quarter, leading NAB economists to conclude: “hardly a slow down”. Such conclusion, though, appears out of synch with what is happening with global shipping rates and iron ore prices. Both certainly seem to suggest activity in China has not just slowed down, it has done so markedly.
Lastly, I think all of the above is best illustrated with some charts. I have taken one from Danske Bank which shows, on their own calculations, that adjusted Chinese growth has fallen from above 12% to 8% in the space of three months. The second one is from CommSec and shows the rate of decline in industrial production – equally pronounced.
As is clearly shown on the CommSec chart, industrial production in China hasn't been this low for many years (GFC not included).
All in all, the latest China data give plenty of ambiguous material for the bulls and the bears to pick from, bottom line however is that the rate of decline was faster than most would have anticipated and as such the data are now causing additional cuts to growth expectations (albeit mild ones).
If you are reading this story through a third party channel and the charts are not included, I apologise. Technical limitations are to blame.
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