china outlook update june 2011

8/6/2019 China Outlook Update June 2011

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Emerging Markets Outlook June 3, 2011

For Required Conflicts Disclosures, please see page 3

EM OUTLOOK UPDATE: CHINA – Tighter policy gaining traction June 3, 2011

Key Points & Strategy Forecast Table (all % except FX cross) Recent activity data suggest that Chinese growth is

moderating in response to recent policy moves but shouldremain solid over the rest of the year.

Inflation measures have also ticked lower. Price pressuresshould ease later this year but near-term risks are skewed tothe upside, pointing to more rate hikes in coming months.

We also expect more CNY gains - we forecast USD/CNY tofall to 6.20 by end-2011 and have initiated a short NDF trade.

2008 2009 2010 2011F 2012F

Real GDP growth 9.6 9.1 10.3 9.5 9.5Inflation (Dec) 1.2 1.9 5.0 3.0 3.5Gov’t balance/GDP -0.4 -2.2 -1.6 -1.5 -1.0Current Acc’t/GDP 9.4 6.0 4.9 4.5 4.5

(end of period) 11Q1 11Q2 11Q3 11Q4 12Q4

1-year lending rate 6.06 6.56 6.81 6.81 6.81USD/CNY 6.50 6.40 6.30 6.20 5.80

Source: RBCCM

Graph 1: IP and PMI data point to moderating but solid growth

0

5

10

15

20

25

30

35

40

2008 2009 2010 2011

38404244464850525456

5860

headline PMI (LHS)investment (y/y growth YTD) (RHS)industrial production (y/y growth) (RHS)

Source: Bloomberg

index percent

Graph 2: Headline inflation stabilizing but risks skewed to the upside

-12-10-8-6-4-20246810121416

2004 2005 2006 2007 2008 2009 2010 2011

purchasing price indexconsumer price indexproducer price index

percent

Source: Bloomberg

Growth solid but moderating as policy gains traction• April data suggests that solid growth has extended into

Q2, but at a pace somewhat below that recorded in Q1,

indicating that recent policy tightening is gaining traction.Industrial production growth, in particular, slowed from14.8% y/y in March to 13.4% in April, the lowest readingsince last November. April and May PMI data also pointto a deceleration in the manufacturing sector. Retail salesgrowth also eased, although investment remains strong,supported by ongoing infrastructure spending and publicsector housing construction. New bank lending alsoremained strong at CNY740 billion in April, while tradedata showed that external demand is continuing toprovide strong support to headline growth. Overall, then,recent data does little to suggest China is facing a “hardlanding” over the next few months but does point to somemoderation in activity over the rest of the year, consistentwith our forecast for annual GDP growth to fall from10.3% in 2010 to 9.5% in 2011.

Inflation should ease in H2 but upside risks still serious• CPI inflation eased slightly in April from 5.3% to 5.2%,

primarily due to a smaller increase in housing costs,while PPI inflation also pulled back from 7.3% to 6.8%,consistent with recent PMI input price data. We continueto expect price pressures to moderate later in the year.Much of the recent pick-up in headline inflation reflectsbase effects from earlier weakness in prices, withofficials estimating this to have contributed 3.1percentage points of the 5.3% increase in consumer

prices in April. These base effects should turn morefavourable in the second half of the year as y/ycomparisons are made with a period of higher prices.Previous policy tightening should also have a greaterimpact as the year progresses. Nevertheless, risks areskewed to the upside in the near-term. In particular,higher oil and commodity prices at the start of the yearare still to have their full impact on headline measures of inflation, while poor weather conditions could also sendfood prices sharply higher again in the next few months.

INVESTMENT STRATEGY

FX Local FI External DebtAsset Allocation

O/W M/W N/A

Top Trade Recommendations:

Sell 12-month USD/CNY NDFs





Graph 3: Policy rates up sharply over last six months, but more coming

-2-10123

456789

2006 2007 2008 2009 2010 20115.06

5.31

5.56

5.81

6.066.31

6.56

6.81

7.06

7.31

7.56

benchmark lending rate (LHS)consumer price index (RHS)

percent

Source: Bloomberg

percent

Graph 4: CNY trending higher against USD, but scope for more gains

86889092949698100102

104106108

18-Jun 30-Jul 10-Sep 22-Oct 03-Dec 14-Jan 25-Feb 08-Apr 20-May

CNY/EURCNY/USDCNY/JPYRBC NEER

index: 18/06/2010=100

Source: Bloomberg, RBC

More rate hikes on the way• These near-term upside risks to inflation suggest there

will be little complacency in Beijing about the inflationoutlook despite signs that growth is moderating. Seniorofficials, including Premier Wen, have stressed thatcurbing price pressures is their key economic priority thisyear, clearly indicating that further policy moves are

likely in coming months. We forecast another 25bpsincrease in policy rates by the end of Q2, and thenanother one in Q3 to take the benchmark lending rate to6.81%. Further hikes in banks’ reserve requirements arealso likely.

Short-term and long-term goals point to stronger CNY• We also expect CNY to strengthen further against USD

in the months ahead as part of Beijing’s efforts to curbprice pressures, with officials now more explicit aboutthe role currency appreciation can help to play inreducing imported inflation. High inflation providespolicy-makers with the motive to move faster on thecurrency, while solid export growth provides them withthe opportunity to do so. CNY has also been flat on atrade-weighted basis in recent months, suggesting there isample scope for further moves higher against USD.

• Longer-term goals also point in this direction. Seniorofficials – including Premier Wen – have indicated that amajor goal over the next 5-year plan is to rebalance theeconomy away from an over-reliance on exports and“unsustainable” investment and in favour of households.Such a transition would allow (and be assisted by) amove to a stronger currency, which would drive changesin China’s manufacturing sector while also boosting thepurchasing power of Chinese consumers. Ongoing effortsto develop CNY’s status as an international currencyshould also support the longer-term appreciation trend.

• Reflecting our forecast for solid CNY gains, we haveinitiated a short 12-month USD/CNY NDF traderecommendation at 6.382. Although we have a broadlydefensive stance for EM FX in the near-term, CNY is arelatively low-beta currency, and we now see value inthis trade – 12-month NDFs backed up from around 6.30over May as global risk appetite weakened, suggestingthat richness/over-positioning has diminished, whileimplied yields have also moved to more favourablelevels. We expect moderate gains over the rest of theyear, forecasting spot USD/CNY to keep falling steadily

to around 6.20 by year-end, compared with around 6.43implied by the NDF market.

Graph 5: Policy rate and currency forecasts

5.04

5.31

5.58

5.85

6.12

6.39

6.66

6.93

7.20

7.477.74

2008 2009 2010 2011 2012

6.006.25

6.50

6.75

7.00

7.25

7.50

7.75

8.00

8.25

8.50

policy rate (LHS)USD/CNY (RHS)

percent USD/CNY (inverted)

RBCforecasts

Source: Bloomberg, RBC





Emerging Markets Research TeamRBC Dominion Securities Inc.TorontoNick Chamie, CFA(Global Head – Emerging Markets Research) (416) 842-2802 [email protected] Biszko, CFA (Senior Emerging Markets Analyst) (416) 842-2802 [email protected]

Eduardo Suarez (Senior Emerging Markets Analyst) (416) 842-2802 [email protected] Carabajal (Associate) (416) 842-2802 [email protected]

Royal Bank of Canada Europe LimitedLondonNigel Rendell (Senior Emerging Markets Analyst) +44-20-7029-7403 [email protected] Beange (Head –EEMEA Strategy) +44 20-7029-0098 [email protected]

Royal Bank of Canada, Hong Kong BranchHong Kong

Brian Jackson, CFA (Senior Emerging Markets Analyst) 852-2848-5173 [email protected]

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china outlook update june 2011

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