Sunday, March 2, 2014

China official PMI softens

China’s official PMI index fell from 50.5 in January to 50.2 in February, slightly better than consensus expectation of 50.1.  All sub-indices bar one (suppliers delivery times) were weaker in February than January.  As I said with the release of better-than-expected trade data recently it’s important not to read too much into the Chinese data at the start of the year as it can be quite noisy.  That said the two most critical of the sub-indices, production and new orders, showed bigger declines than the overall index which shouldn’t be dismissed too readily.

Our forecast for China GDP growth this year is 7.5% which is a modest deceleration from the 7.7% recorded in 2013. As you know there are two critical and offsetting factors that will determine the growth outcome in China this year; the extent to which higher export growth on the back of higher global growth offsets the weakness in investment given the tightening in credit conditions.  Given our view that higher exports would come later in the year, our expected profile of GDP growth over the year is for it to start off soft and end the year modestly higher.  The PMI data is certainly supporting the first (and easiest!!) part of that story.

The other newsworthy development in China has been the recent decline in interest rates and the exchange rate.  Given the lack of transparency around the PBOC its actions are open to debate and conjecture.  Given the weakness in some of the recent data those market movements could be interpreted as an easing in monetary conditions to support growth.  Or worse, the exchange rate appreciation could be seen as an abandonment of the leadership’s intention to rebalance the economy.

I don’t think it’s either of those things.  Part of the intention to liberalise financial markets is to allow a greater role for the market in determining financial market prices.  With respect to the exchange rate, we think PBOC is simply wanting to introduce two-way volatility into the exchange rate, leading eventually to a widening of the trading band. That also helps send the message that CNY appreciation is not a one way bet.  We expect the CNY to continue appreciating this year.  Fundamentals support continued appreciation with the current account still in surplus, although at 2.1% of GDP in 2013, it is much reduced recently.  Also, continued Fed tapering and the resultant reduction of capital inflows (and possibly outflows) will also limit the appreciation.

Another important part of the China story will unfold this week with the announcement of the official growth target for 2014.  We expect it to remain unchanged from last year at 7.5%.  While we dont think recent financial market developments are a concerted effort to ease monetary conditions, given benign inflation there is room to move on both monetary and fiscal policy should the China leadership become concerned about the growth outlook.