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China Economy - December 2011

Source: OPEC 1/10/2012, Location: Asia

Continued strong rise in sales to the emerging markets, particularly in Southeast Asia. The HSBC China purchasing managers' index (PMI) for October showed new export orders growing at their strongest rate in nine months. However, data for October suggests that the economy is continuing to slow. Industrial value-added growth decelerated marginally in October. Retail sales growth also cooled slightly from 17.8% in September to 17.2% in October. There are fears that sales of household appliances and consumer electronic goods could be hit in the coming months as a subsidy programme comes to an end. A subsidy scheme for car purchases was ended earlier this year. Since then, sales have languished.

Vehicle sales in October were down by by 1.1% y-o-y at 1.5 million vehicles, although passenger cars posted a slightly better performance, growing by 1.4% to 1.2 million units (EIU, Country report, December 2011). Fixed asset investment in urban areas continued to grow at a fast pace in the first nine months of 2011, up by 24.9% y-o-y. But figures might look mixed and confusing in the construction sector because iron ore prices tumbled in October, having fallen by almost 36% since mid-September.

This would seem to indicate deteriorating prospects for the construction sector, whose demand for steel drives iron ore prices. One explanation might lie in the government's social housing drive that, despite the announcement of the start of work on 10 million new social housing units, roughly one-third of the projects has seen little real activity. Despite the slowing economy China's domestic energy supplies remain tight. The State Electricity Regulatory Commission (SERC) issued a warning in October that power shortages were expected this winter as high coal prices were putting pressure on power-generating firms and many electricity plants were operating at a loss.

In November, the Government also instructed two state-owned oil companies, China Petroleum & Chemical Corporation (Sinopec) and the China National Petroleum Corporation (CNPC), to ensure adequate diesel supplies by maintaining oil refineries at full capacity. The two firms account for around 75% of China's diesel refining capacity.

A deceleration of the real sector of the economy has begun impacting the monetary part of the economy and China's national currency, the renminbi. As reported by the Financial Times (7 December 2011), despite the Chinese central bank's efforts on supporting the renminbi, the currency has fallen to the bottom of its official trading band for six straight days againsthe US dollar, an unprecedented indication of the Chinese currency’s potential weakness as the economy slows. Beijing has so far acted to keep the renminbi largely stable against the dollar by supporting its value, but the intervention is prompting growing discussion about whether the renminbi could depreciate, or at least become considerably more volatile. The central bank controls the renminbi within a narrow trading band, setting a daily reference rate and then letting it fluctuate up or down by 0.5% from that level.

Looked in isolation, the central bank’s daily fixing shows the currency to have been steady against the dollar, even appreciating a tiny amount over the past week. But since early December, the renminbi has gone “limit down” every day, falling 0.5% against the dollar, only to be propped back up by the central bank. As observed by Financial Times' commentators (8 December 2011), the currency has never come under such sustained selling pressure, not even at the height of the global financial crisis in late 2008.

Signs of central bank intervention first showed up in a fall in foreign exchange reserves in September, the first monthly decline in more than a year. That was reinforced by data showing that renminbi positions created to buy foreign exchange fell in October, the first decline since 2007 and seen by many in the market as evidence of capital outflows. Few analysts think the renminbi has much scope to weaken against the dollar because an official devaluation would risk sparking a dispute with the US, where critics maintain that the Chinese currency is still artificially cheap. But Chinese policymakers have started making the point that a smaller trade surplus has pushed the renminbi close to a fair market value. For example, Li Yang, a former adviser to the central bank, was quoted in official media as saying that the renminbi was nearing its “equilibrium level”. Speaking at a news conference, Chong Quan, Deputy China International Trade Representative, said it would be natural for the currency to rise and fall in a wave-like pattern.

However, renminbi volatility is not just limited to the mainland. In the offshore market, based in Hong Kong, the renminbi suffered record falls against the dollar in September as international investors liquidated their bets on renminbi appreciation. Until three months ago, the offshore renminbi, known as CNH, traded at a premium to its onshore equivalent, known as CNY. That premium has since swung to a discount and in the second week of December the offshore renminbi was trading almost 0.15% weaker than the onshore rate against the US dollar.

In October, the pool of renminbi deposits in Hong Kong shrank for the first time in two years, falling by 0.6% from the previous month. Meanwhile, the amount of cross-border trade settled in renminbi, the initiative at the heart of China’s plan to internationalize its currency, also declined for the first time in the third quarter. In a longer-term setting, the performance of the economy looks brighter as inflationary pressures slowed down significantly in October compared to August. The cooling of inflation is not only welcomed by the business community, but it also re-opens the possibility for a more accommodating monetary policy.

Money supply, M2, increased by a modest rate of 13.1%, y-o-y in September, the lowest growth since 2001. Bank lending increased by a higher-than-expected rate in October. This might signal a shift towards loosening monetary policy. The People’s Bank of China (PBC, the central bank), has recently been adding to the amount of liquidity in the economy through less aggressive sterilization efforts. According to the EIU (Country report, December 2011), there has been speculation that the PBC could also offer a longer timetable to meet the tougher reserve requirement standards that were strengthened in August to prevent the economy from overheating.

China’s aggregate fiscal stance remains robust. Central government revenue increased by 28.1% in January-October 2011 y-o-y. Revenue growth has outpaced the 27.2% y-o-y increase in public spending. However, regional governments’ finance remain opaque, owing to large off-budget spending and income. Local governments’ debt has soured in recent years, due to many infrastructure projects undertaken by local authorities. However, the fiscal woes of the regional governments have mounted in recent months as land sales, one of their key revenue streams, have begun to suffer amid growing trouble in China's real estate market.

Ahead of major changes in the political leadership of the country, expected in 2012, senior officials in other parts of the government are already being reshuffled. In October, the country's key financial regulatory bodies received new chiefs. Meanwhile, the former chairman of the state-owned China Construction Bank (CCB) will head the China Securities Regulatory Commission (CSRC). These personal changes, however, are not expected to lead to any sharp reversals in policies.

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