- China's June data were slightly weaker than expected, with production and inflation slowing.
- A gradual trend towards lower but robust and sustainable growth is expected at this stage.
- Exports may underperform in coming months.
China's June data were almost uniformly weaker than in May. Industrial production and fixed asset investment growth are both well below their peaks in year-on-year terms, and GDP growth has fallen from its first quarter peak (see chart, “Chinese Growth Peaks”). Electricity and crude oil output growth also weakened in June, suggesting reduced activity in metal refining and other energy-intensive sectors.
Meanwhile, according to the purchasing managers' index, sentiment is cooling (see chart, “Double Dip?”). Sentiment on new orders and new export orders declined significantly, although managers remain optimistic on net.
The release of the June data caused a decline in market expectations of yuan appreciation over the medium term, implying markets believe that the government will slow the pace of policy tightening. Commodity prices declined, as did currencies such as the Australian dollar, as markets revised down expectations for China’s demand for commodities.
Fears of a sharp downturn are overstated at this stage, however. Growth in year-on-year terms was expected to moderate as the weak base from a year ago disappeared. Global risk aversion because of sovereign debt problems in Europe may have reduced manufacturers' orders and sentiment in June, but the relative calm since then may prompt a rebound.
We retain our baseline forecast for a soft landing in the Chinese economy. The government’s 8% GDP target for 2010 is assured, but sustaining growth in 2011 is the next challenge.
Cooling inflation, for now
Producer and consumer price inflation weakened in June (see chart, “Inflation Trend Flattens”). Lower commodity prices (notably for fuel and food) dampened inflation. These factors, coupled with slowing property price growth, will last for several months. Prices are likely to moderate further in year-on-year terms during the second half of the year.
Upside inflation risks remain, however, and could reassert themselves in 2011. Despite the reduction in bank lending this year, monetary conditions remain highly accommodative, which could fuel another surge in commodity prices. If recent wage increases spread from export-oriented sectors to domestic-focused sectors, then producers may pass the costs on to consumers. Or if wages grow faster than productivity, then household demand may outpace supply.
The outlook for trade
Exports and imports growth moderated in June, although imports moderated to a greater extent and helped push the trade surplus to $20.02 billion, its highest since October (see chart, “China’s Exports Outpace Imports”). Exports to emerging markets such as Brazil and Russia are surging, while shipments to traditional markets such as the U.S. and EU are recovering.
Another reason for relatively strong exports in June was expectations of the removal of export subsidies on 406 product categories, which caused firms to rush shipments out before the subsidies ended. Reduced subsidies on certain steel categories, for instance, may have helped drive steel exports up 253% y/y compared with a 43.9% y/y rise in overall exports. The flipside is that the removal of the export subsidies will result in reduced shipments in coming months. This is likely to reduce the trade surplus but may be partly offset by some exporters focusing more on the domestic market, resulting in reduced import demand.
Exports are likely to face strong headwinds in coming months for a number of other reasons. The main concern surrounding China's export outlook is the sustainability of the global recovery. The U.S. economy appears to be on a sustainable recovery path, but its momentum may slow somewhat later this year. Europe, on the other hand, is expected to slide back into a mild recession. The uncertain outlook for Chinese exports will place greater pressure on policymakers to support more sustainable domestic drivers of growth.
About the Author
Alaistair Chan is an associate economist in the Sydney office of Moody’s Economy.com.