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China’s Confusing Economy

International | Apr 02 2012

By Greg Peel

With disturbing headlines from Europe having dried up over the past month, world markets have redirected their anxiety towards China and the disturbing pace of its economic slowdown. Fear was heightened when Beijing declared a new GDP growth target of 7.5% for 2012, down from the previous 8.0% standard, a few weeks ago, before markets were startled by China's biggest trade deficit since 1989 being posted in February. Next came a fall in corporate profits for the first time in five years and, finally, last week's drop in the HSBC independent manufacturing PMI measure (initial estimate) has been almost the last straw.

But yesterday Beijing turned around and issued its own manufacturing purchasing managers' index (PMI) for March and the published rise to 53.1 from 51.0 has startled economists who were expecting a slip back to just over the 50 mark. In the meantime, HSBC upgraded its own “flash” result to 48.3 from 48.1 but that's still down from 49.6 in February. As a major manufacturing economy, this PMI is very important to Chinese and thus global GDP. But who's number should we believe?

There are two significant differences between Beijing's officially sanctioned measure and HSBC's independently calculated measure. Firstly, the official measure is weighted towards large state-owned enterprises while HSBC weights more towards small and medium enterprises, and secondly HSBC seasonally adjusts its readings while Beijing doesn't.

More than one broker/researcher has pointed out this morning that China's non-adjusted PMI has risen an average 6% every March since 2005, reflecting life returning to normal after the Chinese New Year interruption and subsequent impact on the January and February PMIs. Hence the impact of seasonality weighs more in favour of HSBC's calculation looking more realistic. It also makes sense that manufacturing should ease while China's biggest export customer – Europe – is slowing.

However, Danske Bank suggests HSBC's seasonal adjustment model may distort the PMI a bit too far the other way.

Barclays Capital had expected such a pick-up in the official PMI in April given the flow-through of monetary policy easing, fiscal spending, and projects beginning in the wake of the recent annual government meeting. The analysts now suggest perhaps what they were anticipating had already begun in March. However, Barclays is tipping further slowing ahead, and is forecasting March quarter GDP growth of 8.2-8.5%. The analysts see a rebound by the December quarter to 8.9%.

Morgan Stanley has nevertheless just raised its 2012 GDP forecast to 9.0% from an earlier 8.4%. That's still down from 9.2% in 2011, but a far cry from Beijing's “target” 7.5%.

Still all a bit confusing really.

What just about all economists agree on is that further reductions in Beijing's reserve capital requirement (RRR) for banks will be forthcoming as a form of policy easing despite this apparent PMI bounce. About half of the economists surveyed by Bloomberg also expect an interest rate cut shortly. The government is intent on steering the Chinese economy towards consumption and away from capital spending dependence, Bloomberg notes, which is reducing demand for cement and steel and in the latter case is pushing down iron ore prices. Prices of new apartments fell in 45 of of China's 70 major cities in January, which sounds scary to the rest of the world but comforting for Beijing in its efforts to prick the dangerous property bubble. Standing between an easing of the property bubble (China has a low rate of household mortgages anyway) and a property crash – a soft landing or a hard landing – is Beijing and its monetary policy flexibility.

The biggest driver of the official PMI for March was growth in new export orders, albeit HSBC's number went the other way. Economists remain unshocked by a fall in demand for Chinese exports given the Europe effect and there is a general consensus that while Chinese GDP growth will drift lower in the March and June quarters, a rebound will follow through to the end of the year as a result of more easing from Beijing. Most economists are also forecasting Europe to hit recession in 2012 before climbing back out towards year-end.

The fly in the ointment could be inflation. Chinese headline inflation has fallen back from its mid-2011 peaks which were mostly to do with disruptions to food supplies but the price of oil is also an influential factor. Last month's inflation reading showed a slight rise again, and oil prices have recently been trading in an elevated range. Subtracting inflation from Beijing's interest rates leaves zero real rates, notes ANZ, which is why the ANZ economists expect RRR reductions but not a rate cut any time soon.

The bottom line is that we will continue to worry about the Chinese economy (probably for another decade or more) given its significance to world economic growth and its particular influence over Australia's fortunes. Over the past few years the Chinese government seems to have matured from greenhorn economic manager prone to overreaction into a more astute, delicate tweaker of policy with promising results to date.

If the March PMI offers the potential for distortion, then perhaps we need the April number to clarify the situation. Meanwhile, China's monthly inflation data for March will conveniently be released on Easter Monday while the Beijing's March quarter GDP result is due out on Friday – the thirteenth.

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