Chinese economy in 2010 – Witnessing the recovery

A goldilocks year is in prospect for the Chinese economy in 2010. So far, the capital market panic has been more financial than macroeconomic in character and effect. 4Q and annual GDP growth in 2009 look to be 10.2% and 8.4% respectively, slightly lower than that in 2006-2008 but still admiring. Plunging export has so far been offset by strength in fixed asset investment and consumption in the GDP portfolio. I believe that the good news are now tilted to an outcome in which the slow but healthy recovery of US and European economies and increasing domestic consumption will filter through more noticeably to exports and consumption portion of the economy in 2010.

 

When China will implement an exit strategy from quantitative easing remains unclear. I am impressed by the new assertiveness of PBoC to continue the easing monetary policy as "lack of sufficient external demand still persists, China’s domestic consumption recovery is still not stable". I think the natural reaction is that central bankers will try to maintain the liquidity at healthy but sufficient level. While China’s private sector fixed asset investment, particularly in property sector is picking up, and US and Japan have experienced a bottom out of import, China will only consider an exit strategy until inflation risk is well managed and exports recover to an acceptable level, that said China will not hike interest rate and RRR in the first half of 2010. I expect the new loan growth will sustain at RMB7-8 trillion in 2010, which will be a moderate decline from 2009, but still be able to accommodate the economic growth.

 

As a consequence, I expect the Chinese economy to grow 10.1% in 2010. The upside potential I anticipate in domestic demand would parallel the 1998 post-crisis experience. Whether or not the external demand will slow down, China will ensure the economic growth to maintain at acceptable level, satisfy a growth rate of at least 8%. The message delivered by China’s central bankers is clear, the country still prefers quantity of the economic growth to quality of growth, and China’s external demand imbalance will pick up again, resulting a greater pressure on RMB appreciation.

 

While China no longer suffers the affliction of catching pneumonia every time the US catches cold, it is not entirely immune to a US slowdown either. That said, the dynamism and stronger financial position of the bulk of the US economy should allow China’s GDP to expand at a faster pace in 2010 than in 2008, following bottom out of US economic growth in 2009. Measured at market exchange rates, I expect US GDP next year to show growth of about 3%, up from nearly 0.4% in 2008. Encouraged by the lower dollar, US exports should continue to do well. The worst is behind us, with a healthier balance sheet and bottoming up recovery of housing and automobile market, US economy will lead a recovery and may aggregate a better-than-expected demand for China’s exports.

 

Economists have been labeling the US foreign trade deficit unsustainable for about 27 years. At long last, they seem to be right, as evidenced by the reluctance of foreign investors to support US financial assets and the corresponding drop in the value of the dollar on the foreign exchanges. Think of this as a debt-for-equity swap imposed on an over-stretched borrower called USA, Inc. While potentially awkward from a financial perspective, the effects are consistent with a rebalancing of the American and global economies that provides some cushion. Strategically and commercially, Chinese companies will be increasingly interested in investing overseas, through either M&A or greenfield investment.

 

My expectation for stronger domestic demand growth is primarily consumer- and housing-driven, although the risks in property sector is accumulating. I have long emphasized that China lacks of a well-established social security system and household income of China’s huge rural population has been lagging behind of GDP growth. Hence, the resilience of consumer spending through the last two decades of malaise. But the pace of automobile sales and home appliance sale in rural areas have gain momentum in recent months, particularly as Chinese government has issued several measures to stimulate consumption. The risk is that such measure will not last forever, if the government terminates such subsidies conditions will feed through consumption sector even more noticeably in the coming period. Against the backdrop of encouraging consumer confidence readings, accelerating retail sales and automobile sales, a pick up in consumer spending looks like a reasonable forecast. 

 

The massive liquidity on the market leads me to expect no sharp correction of residential prices through next year. As homebuilders are running out of inventory, local government still has enthusiasm and motivation to encourage property sector development to fund regional public spending, residential investment should continue to pick up precipitously over the immediate few quarters. The affordability level is 1st-tier cities is the main risks that investors need to pay particular attention to, while some investors argue that "since not every New Yorkers can afford a small apartment close to Central Park, why should every Beijinger or Shanghainese should be able to afford an apartment in the downtown", and they also argue that if compared with other Asian developed economies such as Hong Kong or South Korea, the properties in China’s 1st-tier cities are still significantly under-value. While I am not saying every resident in such cities should be able to afford a luxury apartment, the fact is that a typical middle class family is almost impossible to afford a 600sqf apartment in remote areas, that said no matter in which measures, properties prices in such cities have been too expensive to most of people. If we believe there’s a property bubble in some of China’s 1st-tier cities, the bubble will finally burst, and China is not an exception. While I cannot predict the timing of bubble burst, but transaction volume will be a key measure that investors should closely watch out.

 

Easing monetary policy and an improving consumer and profit environment should induce a pick up in business capex, particularly infrastructure construction and property development. Industrial production can be expected to increase too as businesses adjust demand levels upwards; illustratively, the car companies’ Q1 production schedules vehicle assembly rates at very high level, and a large number of new models are lined up to be introduced in the next several months. The good news is that, unlike in the 2000s, debt levels look manageable in the corporate sector, there is little evidence of  NPL pick up in the short-term, and business inventories are reasonably lean relative to sales. These factors could ensure a steady profit growth in industrial sector, perhaps enough to keep the economy on the road of recovery.

 

Headline CPI inflation slowed from -0.8% in September to -0.5% in October on the back of higher closing, healthcare, entertainment and property prices, and it is likely to turn positive towards the year-end in my view. The early winter in this year will boost demand for oil and gasoline, and current oil and gasoline futures suggest some potential of price increase this winter, but headline inflation could remain at manageable level. Meanwhile, the vast portion of China’s new bank loans flew to businesses as long-term loans, and as the single most important segment in China’s CPI basket, the food price still does not show upside signs, I don’t see a high or even hyperinflation for next year. I expect the core CPI to trend around the 2%-3% zone for the foreseeable future.

 

As discussed above, downside risks to the economy from the unstable economic recovery should encourage central bankers to continue the easing measures in 2010, unless China faces greater inflation and overheating pressure. I expect PBoC would only start to tighten the monetary policy in the second half of next year, by justifying interest rates twice, and 27 basis point each time.

 

The good news is that the banking system taken as a whole has a stronger capital position and healthier balance sheet than several years ago. Moreover, there is some real possibility that the NPL problem in China’s banking sector has been overstated. If so, the modest inflation pressure and tightening possibility will bost earnings rebound as overal business environment is improving. With a bit of luck on that front, and despite that both A-share and H-share stocks have been "not cheap", equity investment will bring generous return – as we are ending the year of ox and entering the year of tiger.

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