CNY China V

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Important disclosures can be found in the Disclosures Appendix.Ref: GR_20Jul09

AnalystsLi Wei, +86 21 6168 5017Standard Chartered Bank (China) [email protected]

Stephen Green, +86 21 6168 5018Standard Chartered Bank (China) LimitedHead of Research, [email protected]

Judy H Zhu, +86 21 6168 5016Standard Chartered Bank (China) LimitedCommodity [email protected]

ChinaThe end of the V08:00 GMT 11 August 2009

July data suggests that the recovery continues but is losing some momentum,as expected

Official policy stance remains unchanged, though fine-tuning, especially ofmonetary policy, is expected in the next few months

Some weakness in some commodity imports appearing

Todays avalanche of China data suggests that the economic recovery is solid, but tha t the momentum ebbed

in July. What was a V-shaped recovery now seems to be experiencing a little gravitational pull. A number of

indicators industrial and electricity production as well as fixed asset investment showed either flat or

slightly weaker year-on-year growth in July. New bank loans came in at only CNY 355.9bn (USD 52bn), well

below Junes CNY 1.53trn; as we explain below, this lending went heavily to households rather than

corporates (see Table 1). The slightly weaker-than-expected data means an even smaller chance of an

imminent change in macro policy and lends weight to those who argue that it is too early to tighten. Having

seen the data early, Premier Wen Jiabao restated at the weekend that the goal was to maintain a proactive

fiscal policy and a moderately loose monetary policy.

Table 1: Chinas July data

Growth, y/y July-09 June-09 H1-09 2008 average

CPI -1.8% -1.7% -1.1% 5.9%

PPI -8.2% -7.8% -5.9% 6.9%

M2* 28.42% 28.46% 21.14% 16.67%

FAI, YTD 32.9% 35.3% 35.3% 26.1%

Industrial value added 10.8% 10.7% 7.0% 12.9%

Retail sales 15.2% 15.0% 15% 21.6%

Exports -23.0% -21.4% -21.7% 17.2%

Imports -14.9% -13.2% -25.4% 18.5%Trade surplus USD 10.6bn USD 8.2bn USD 96.9bn USD 295.8bn

* M2 H1-09 is average of month-end data for the six months of H1-09

Sources: NBS, Customs, PBoC, CEIC

Inflation expectations are not an immediate threat

Prices are stable overall, but are of course a lagging indicator of demand. The consumer price index (CPI) fell

by 1.8% y/y in July, compared with a fall of 1.7% y/y in June. The producer price index (PPI) fell by 8.2% y/y,

versus a fall of 7.8% y/y prior, as shown in Chart 1. On a month-on-month (m/m) seasonally adjusted (sa)

basis, however, prices have stopped falling since March. Since then, prices have risen a bit, and in July both

were basically flat, as we show in Chart 2.

| On the Ground |

http://research.standardchartered.com


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On the Ground | 11 August 2009

Ref: GR_20Jul09

Inflationary expectations have risen, though. While the recent PBoC report toed the official line, we know that

the central bank is much more concerned than other government agencies about inflation (see OTG,

5 August 2009, Monetary policy update). We forecast that CPI will return to positive y/y growth around

November. This will likely be one of the triggers of a shift in the overall monetary policy stance. This shift will

likely involve hikes in the required reserve ratio (RRR), which we expect in Q4, to be followed by interest ratehikes in H1-2010, and even possibly loan quotas. The RRR hike is significant, as the PBoC needs the State

Council to sign off before it can go ahead. However, todays data does not bring that day closer.

Chart 1: Prices falling year-on-year.

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CPI, y/y % PPI, y/y %

Sources: CEIC, SCB Global Research

Chart 2: . . .but stable m/m

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CPI, m/m sa % PPI, m/m sa %


All eyes on infrastructure projects and real estate

Fixed asset investment (FAI) continued to grow in July we calculate a 29.7% y/y increase, as shown in

Chart 3. (In real terms, FAI rose even faster, by around 34% y/y.) Given the large volume of planned

investment, the accommodative policy stance, and the gradual recovery in private investment, we expect FAI

to remain strong. However, it appears as though the momentum has ebbed here, too. The nominal growth

rate of 29.7% y/y in July was a deceleration from the monthly average of 35% y/y in Q2. (This data, though, is

problematic, so we do not have huge confidence in it alone.) However, corroboration is provided by project

data. There were only 29,600 new project starts in July, compared to a monthly average of 41,060 in

Q2-2009. In fact, July saw the first negative month-on-month growth in new project starts since October 2008

(adjusting for Chinese New Year). This is further evidence that the stimulus package was heavily frontloaded,

meaning that investment growth may well plateau around these levels for a while.


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Ref: GR_20Jul09

Chart 3: Continuous strong FAI growth

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FAI growth, y/y %, 3mma


Chart 4: Are house prices too high now?

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Housing investment, y/y %, 3mma

Housing sales, y/y %, 3mma (RHS)


This view is supported by the still-muted recovery in real estate investment. Real estate FAI only rose by

12.7% y/y in July, lower than Junes 14.6% growth (as shown in Chart 4), and still well below the 30% rates

we witnessed over 2006-07. Housing sales, measured by floor space sold, grew by 69.6% y/y, up from Junes

54%. However, sales volume fell by 20.3% m/m in July, following growth of 35.3% in June. In Shanghai,

many developers seem to be keen to hold on to apartments, waiting for further price rises before they release

them. They are also probably not keen to start a massive wave of new projects until they feel surer about the

medium-term future. New home prices rose by 1.1% m/m in July, according to official numbers, up 0.3ppt

from June (though these numbers look very low to us in Shanghai many apartment blocks are 30%+ upsince January). There is some worry, both in the market and from officials, that the rises in home prices may

have started to weigh on demand, especially among first-time buyers.

Industrial production growth flattened despite a stronger PMI

Industrial value added (IVA) grew by 10.8% y/y in July, following a 10.7% rise in June (see Chart 5). While

strong, this was below market consensus and suggests some deceleration in production momentum. The

recovery in electricity production also weakened a bit, with growth slowing to 4.8% y/y from 5.6% y/y in June

(though electricity production was up 18% m/m). Demand from stimulus-related infrastructure projects and

the end of the de-stocking cycle have been behind the improvements seen here since Q2-2009.According to

the Purchasing Managers Index (PMI), manufacturing new orders are still growing month-on-month, as

shown in Chart 6. Inventories of finished goods fell by 2.2% y/y in July, suggesting that firms will beincreasingly willing to build inventories of finished goods in the next few months (see OTG, 3 August 2009,

Through the inventory cycle).


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Ref: GR_20Jul09

Chart 5: Industrial production flattens

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IVA, y/y %

PMI production, y/y %


Chart 6: PMI suggests an end of destocking

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New orders

Purchases

Finished-goods inventories


Retail sales stabilise on recovering confidence

Retail sales rose by 15.2% y/y in July. In real terms, as shown in Chart 7, growth seems to have plateaued at

around 17% y/y. According to eziData, consumer confidence continued to recover in June, as we show in

Chart 8. Car sales continue to motor along.

Chart 7: Sales stablise

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Nominal retail sales, y/y %, 3mma

Real retail sales, y/y %, 3mma


Chart 8: Recovering consumer confidence

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eziData China Consumer Confidence Index(CCCI)

Baseline survey, April 2007 = 100


Far fewer new loans to the corporate sector

CNY 355.9bn (USD 52bn) of new loans were extended in July, a considerable slowdown compared with

CNY 1.53trn (USD 225bn) in June, as we show in Chart 9. Digging into these numbers shows an even

sharper slowdown in lending to the corporate sector. CNY 236.5bn of the net increase went to households,

who were busy buying homes with mortgages, while only CNY 119bn went to corporates (CNY 198bn worth

of bills were repaid in July, as were CNY 58bn in short-term loans, while CNY 350.9bn worth of medium- and


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Ref: GR_20Jul09

long-term loans were extended). Net extension of credit to the corporate sector in July was thus the smallest

since November 2007, according to our numbers. After the blowout in June (when CNY 1.228trn of net loans

were extended to corporates), a sharp slowdown was always going to happen, but this may still unnerve the

market and is another signal that the momentum has dissipated. There is still no shortage of money supply

growth, though broad money supply (M2) rose by 28.42% y/y, as we show in Chart 10.

Chart 9: Exploding new loan extension

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Medium- and long-term, CNY bn

Short-term and bill finance, CNY bn


Chart 10: Explosive money supply growth

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M2, y/y % CNY loan, y/y %


Based on our understanding, the PBoC will be happy to maintain new loan growth at CNY 400-500bn (USD

59-73bn) per month for the remainder of the yearCNY 2.5trn (USD 366bn) for all of H2-2009, or CNY 10trn

(USD 1.5trn) for the whole of 2009. The July data will calm some nerves. Anecdotal news suggests that

demand for loans is still strong, so all eyes will be on the August numbers to see if July was just post-June

exhaustion or if it really did mark a change.

Imports up

Exports fell by 23% y/y in July, and imports fell by 14.99% y/y both a little weaker than June in y/y terms.

We show the three-month moving averages in Chart 11. In month-on-month terms, some positive momentum

continues exports are rising 5% m/m in nominal terms on a 3mma basis, while imports are rising 7% on the

same basis. We do not have volume data for July yet, but looking at June, we note an important shift on the

import side. In real (volume) terms, imports grew by 3.7% y/y in June, while exports continued to fall, but thedecline slowed to 14% y/y. (Chart 12 shows these numbers on a 3mma basis, which disguises the recent

strength a bit but also removes some of the volatility.) We suspect that this trend continued in July another

sign that domestic demand has recovered but that there was no further acceleration in July. The trade

surplus of USD 10.6bn in July was bigger than expected, but not by much.


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Chart 11: Imports are recovering (nominal)

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Export, y/y %, 3mma

Import, y/y %, 3mma


Chart 12: Imports are recovering (real)

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Less arbitrage buying of commodities

China has reduced speculative imports of some commodities, mainly copper and aluminium. In some other

commodities, such as crude oil and iron ore, imports have increased alongside a recovery in demand and

anticipation of further price hikes. Here, we discuss copper and iron ore.

As Chart 13 shows, Chinas imports of copper and copper products dropped from a record high in J une to

406.6 thousand tonnes (kt) in July. We estimate that of the July imports, around 325kt was refined copper,

down 14% m/m. This is the first time that imports have fallen m/m in seven months, although the numbers are

still much higher than a year ago. The difference between London and Shanghai prices has meant that

imports have been loss-making since early June. With few arbitrage opportunities in July, we expect Chinas

copper imports to fall further in August.

Chinas iron ore imports in July continued to reflect a mixture of real demand and speculation. They hit a new

record high of 58.08mn tonnes, up 47% y/y and 5% m/m, as Chart 14 shows. Imports in the first seven

months of 2009 rose by 32% y/y to 355.4mn tonnes. While record-high crude steel production has

encouraged these imports, trading houses continue to import because they anticipate even higher steel

production and higher prices in the coming months. Meanwhile, these traders continue to have access to

easy credit from local banks. But we also note that some traders have already started to take a more cautious

view of imports because of higher ore prices and some weakness in domestic steel prices. According to

Steel Index, an industry publication, 62% iron-content iron ore fines delivered to China hit USD 104.1 per dry

tonne yesterday, the highest level since the index began on 21 November 2008. An additional risk is that

banks may tighten credit lines, but so far we have not heard of any instances of this.


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Chart 13: Copper importsThousand tonnes

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Copper and copper products

2007-2008 monthly average

Sources: Chinese customs, SCB Global Research

Chart 14: Iron ore importsUSD/tonne

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Iron ore 2007-2008 monthly average

Sources: Chinese customs, SCB Global Research


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Ref: GR_20Jul09

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