- Strong quarter-on-quarter GDP growth in Q4 2012 and a pickup in industrial production growth during Q4 2012 mean that China enters 2013 with healthy growth momentum.
- Domestic demand growth held up in H2 2012, especially investment in real estate and infrastructure, while progress was made with the inventory adjustment in industry. Our outlook is influenced by two views: a) potential GDP growth remains robust, although it is trending down, and b) China’s macroeconomic vulnerability remains fairly low, even if it is not as low as four years ago.
- On January 18, after the strong Q4 data, we revised up our forecast for GDP growth in 2013 to 8.4%. We still assume a moderation in quarter-on-quarter growth in H1 2013, but do not expect much of a slowdown in H2 2013 since the global economy should do better in H2, after a weak start.
- We project year-on-year CPI inflation to be around 3-3.5% in 2013. While food prices are on the rise, we expect core inflation to remain under control.
- While we think that the government still has some space to ease the policy stance if needed, the inclination to use macro policy to stimulate growth is tempered by policymakers’ concerns about financial risks and inflation. On the margin, such considerations may imply a larger role for pure fiscal policy in the coming years.
- We expect the budget for 2013 to include some measures to boost household income and consumption, support SMEs, and something on improving the ‘income distribution mechanism.’
- The depreciation of the Japanese yen has led to some weakening of the renminbi, and more so the Chinese currency traded offshore (CNH). However, amidst continued solid productivity growth, we think the CNY will have to continue to strengthen to contain the current account surplus.
- While global factors still form a key risk to our outlook, there are also domestic risks, including from further tightening measures on the property market.
GDP growth rose to 7.9% year-on-year in Q4 2012. According to our estimates, this means a pick-up in quarter-on-quarter GDP growth from 8.1%, SAAR (seasonally adjusted annual rate), in Q3 to 9.5% in Q4.
Industrial production growth strengthened during Q4 from 9.6% in October to 10.3% in December, indicating that the economy entered 2013 with healthy growth momentum.
A literal interpretation of the external trade data suggests a sizeable contribution of net foreign trade to growth in Q4, after net trade was broadly neutral for growth in Q1-Q3. On the basis of the reported year-on-year GDP growth – with which we are generally comfortable – this would imply that year-on-year domestic demand growth decelerated significantly in Q4.
However, our estimates suggest that underlying export growth was less strong in H2 2012 than the trade data indicate, and we think that domestic demand growth did not decelerate much in H2 2012. This view is supported by other National Bureau of Statistics (NBS) data on investment and consumption.
The household survey data suggests a gradual slowdown in real household consumption growth through Q3 alongside an easing of income growth. On our estimates, the national accounts data on the contributions to GDP growth imply that (total) consumption growth, including government consumption, slowed from 9.7% year-on-year in 2012 H1 to 8.5% for 2012 as a whole.
The expansion of total investment (‘gross capital formation’) eased ever so slightly in H2. On our estimate, it comes out at 8.2% for 2012 as a whole.
This includes the impact of changes in inventories, which probably subtracted from growth in 2012 because of the destocking in industry after the involuntary build up earlier. The data on stocks in industry suggests that good progress was made in 2012 H2 towards destocking.
Focusing on fixed investment, notwithstanding the objective to rebalance the pattern of growth towards consumption, the policy support for investment in H2 2012 meant that, on our estimates, gross fixed capital formation outpaced consumption again last year.
Even though monthly data on FAI (fixed asset investment) growth is seriously inflated, in our view, its evolution gives a good indication of the growth dynamics. It confirms that investment growth held up in H2.
The detailed FAI data shows that in Q4, real estate investment growth picked up after having bottomed out mid-year. Infrastructure investment growth reached a plateau after its impressive recovery through 2012 (see chart below).
A Mixed Picture in Investment
Both were supported by accommodative financial conditions, with ‘total social financing’ expanding robustly. FAI in manufacturing continued to slow down amidst weak profitability and spare capacity in several sectors.
In all, while the activity data requires a lot of careful interpretation, we conclude that domestic demand growth held up well in H2, that of investment in particular.
Inflation on the rise
Consumer Price Index (CPI) inflation rose to 2.5% year-on-year in December, as the coldest weather in 28 years pushed up vegetable and other food prices. This followed earlier pressure on the prices of pork and other meat products.
We estimate that food prices rose 1.1% month-on-month in December after a 0.8% increase in November, pushing them up 4.2% on a year ago. Meanwhile, weekly data for the first half of January indicates further food price pressure, especially in the case of vegetables.
We think the pressures on vegetable prices from the bad weather should unwind after the Chinese New Year (11-13 February), although in our view the pressures on meat prices are likely to be sustained for longer.
We expect year-on-year CPI inflation to be choppy in the first months of 2013 because of base effects. It will rise to around 3.5% in mid-2013.
This forecast takes into account some pressure in the pipeline from recent hikes in industrial raw commodities such as iron ore, although other raw commodity prices that matter for China, such as those of soy beans and oil, have either risen less in recent months or fallen.
The NBS estimated that PPI prices fell 0.1% in December to a level 1.9% down on a year ago.
Another reason we are not concerned about inflation is that core inflation continues to be under control – it was 1.6% in December. We expect that to continue, given downward pressures on prices on many manufactured goods amidst ample capacity.
A reasonably good 2013
Our forecast for growth in the coming years is influenced by two views.
- With ample room remaining for productivity catch up and domestic growth drivers still in place, potential GDP growth remains robust, although it is trending down gradually from around 8.5% now to 8% in 2015 and 7% in 2020.
- China’s macroeconomic vulnerability – the kind that goes beyond specific risks and that could lead to turmoil and a downturn in spite of growth drivers – remains fairly low, even if it is not as low as four years ago.
We have revised up our forecast for GDP growth in 2013 after the strong Q4 data. We still assume a moderation in quarter-on-quarter growth in 2013 H1. Nonetheless, on the back of the stronger growth momentum in end-2012, with quarter-on-quarter growth of 8.2% SAAR in the four quarters of 2013, whole-year growth would come out at 8.4%.
In terms of domestic growth drivers, we expect real estate and infrastructure investment to remain supportive to growth, although concerns about financial risks are likely to limit monetary easing.
Even though profits are recovering, we think corporate investment will face some downward pressure from weak profitability lately and spare capacity.
Stockbuilding and exports
On balance, final domestic demand – consumption plus fixed investment – may lose some pace during 2013. However, stockbuilding should shift towards being a positive for growth.
Also, after a weak start, we expect the international growth environment to improve during 2013 as demand in the US and Europe picks up pace. This should help strengthen export growth in 2013 H2 and may prevent sequential GDP growth from slowing down substantially.
For the year as a whole, assuming global import growth of 4%, and global market share gains as in 2012, we project 6.8% export growth in 2013 in real terms. In 2014 China’s growth should benefit from a more convincing recovery in the global economy.
Macro policy to be supportive
We think that the government still has space to ease the macro stance in 2013 if needed. However, the inclination to use macroeconomic policy to stimulate growth is tempered by policymakers’ concerns about financial risks and leverage, in addition to those about inflation.
Policymakers have in recent months started to express concerns about the risks posed by the rapid expansion of ‘shadow banking,’ the less strictly regulated part of the financial system where savings in ‘wealth management products’ are channelled to lending by ‘non-bank’ entities, often owned by the large banks.
One concern is that the shadow banking system tends to lend more to higher risk firms and local government vehicles that have difficulty getting access to normal bank lending.
In 2013, policymakers will need to weigh the case for supporting growth by further monetary easing against the need to contain such financial risks.
The current rise in inflation affects the policy stance. Even though we do not think inflation will rise excessively, the expected pick up makes interest rate cuts in 2013 very unlikely.
On the contrary, they increase the likelihood of an interest rate increase later this year. That is because China’s monetary policymakers use a range of levers to influence the monetary stance.
In the specific case of the interest rate, a key consideration for policymakers is to ensure that, with inflation rising, the real deposit rate does not fall too much. This is especially so in the context of a move of savings out of bank deposits into wealth management products that offer higher rates of return.
At the margin, policymakers’ concerns about financial risks and lending by local government investment platforms may shift the balance somewhat from the traditional emphasis on bank-lending-oriented stimulus to pure fiscal stimulus, financed by government bond issuance.
Our analysis suggests that the impact of fiscal policy on growth is quite large, compared to that of monetary stimulus.
In the fiscal area, in addition to the constructive attitude to approval of infrastructure projects, we expect the budget for 2013 to be approved by the National People’s Congress in March 2013 to include some measures to boost household income and consumption and support SMEs, and something on improving the ‘income distribution mechanism,’ although the latter is unlikely to lead to macroeconomically significant measures, in our view.
What about the renminbi?
The recent depreciation of the Japanese yen has put downward pressure on many Asian currencies, including the CNH (the market-based CNY equivalent in Hong Kong).
At the same time, our medium-term exchange-rate framework suggests that, because of China’s rapid productivity growth in tradables, the CNY will have to appreciate trend-wise by some 1.8% per year on a real effective basis to prevent the current account balance from swelling again.
This implies around 2.5% REER (real effective exchange rate) appreciation vis à vis high-income countries such as the US.
What does this mean for the CNY in 2013? The People’s Bank of China has at times in 2012 allowed the exchange rate to respond to market pressures, leading first to an appreciation against the USD and later to a strengthening.
In our view, policymakers would, over time, like to move to a more market-oriented exchange-rate regime, both for its own sake and in order to help promote the internationalisation of the RMB. We also think policymakers would, if possible, like to see more two-way volatility.
However, we think pressures on the FX market will complicate rapid movement in that direction. In our view, China will continue to face balance of payment (BoP) pressures because of the sizeable current account surplus, the underlying driver of BoP surpluses.
We believe real economy considerations remain paramount in the setting of financial policies. In the case of the exchange rate, that means not letting it appreciate too rapidly. Therefore, we expect the pressures to lead to continued heavy management of the exchange rate, while allowing some gradual appreciation.
The China risks
Risks to our outlook include a weaker global outlook, while domestic risks centre around investment.
Real estate investment could be hit if rapid housing price rises elicit further tightening policies vis-a-vis the property sector. Infrastructure investment may disappoint if concerns about financial stability constrain its financing.
There are also upside risks, including a possibly better global environment.
We do not expect a rapid change in the reform process after the leadership transition. However, recent steps seem to support our view that the government could possibly formulate and embark on a more comprehensive approach to rebalancing the pattern of growth and urbanization.
About the Author
This article is excerpted from “Top View: China,” a report by Royal Bank of Scotland and affiliated companies that was published on 1 February 2013. It has been re-edited for conciseness and clarity.
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