china’s macroeconomic outlook: monetary tightening

China’s Macroeconomic Outlook: Monetary Tightening

Don Hanna

Asia Pacific Economic and Market Analysis

Shanghai

December 2004

See the Disclosure Appendix for the AnalystCertification and Other Disclosures

2 Economic and Market Analysis (Asia Pacific)

Overheating or Overinvestment?

0

5

10

15

20

25

1998 1999 2000 2001 2002 2003Consumption Fixed Capital Formation GDP

%

Growth of consumption, fixed capital formation and GDP (%)

Source: China National Statistics Bureau, CEIC and Citigroup estimates.


Selective Tightening Policies

Policy Measures Implemented

Tightening Liquidity by the PBOC

Reserve requirements have been raised three time since September 2003 and currently the ratios are 8% for weak banks and 7.5% for all others

Window Guidance by the CBRC

Banks have been advised to slow lending to sectors with risks of bubbles and inspection groups have been dispatched to check banks’ loan portfolios

Preferential supports to investment projects in areas such as coal, electricity, oil, transportation and water supply

Control of Land Use by the State Council

Investigation of irregular conversion of land use and tighter procedure for approval of new land development projects

Consolidation of Investment by NDRC

Consolidation through review of investment projects, targeting iron and steel, cement, office buildings, golf course, large shopping centers, etc

However, projects in the following areas are not affected: agriculture, forestry, irrigation, ecological development, education and science

Additional Policy Options

Tightening Liquidity Open market operation or further raising deposit reserve requirement ratios

Interest Rate Hike China began to raise interest rates to avoid negative real interest rates and substitute for administrative measures. Inflation could accelerate the plan

Currency Revaluation Exchange rate policy reform is still driven by fundamental consideration, which may be delayed due to concerns about uncertainty in the economy


Tightening Slows Growth of Monetary Variables

0

5

10

15

20

25

30

Mar-97

Sep-97

Mar-98

Sep-98

Mar-99

Sep-99

Mar-00

Sep-00

Mar-01

Sep-01

Mar-02

Sep-02

Mar-03

Sep-03

Mar-04

Sep-04

Money Supply M2 (% YoY) Financial Institution Loans (% YoY)

% YoY

Growth money supply M2 and bank loans (% yoy)



But Economic Activity Remains Robust

Growth of monthly fixed asset investment in 2003 and 2004 (% YoY)

Growth of monthly retail sales in 2003 and 2004 (% YoY)

0

10

20

30

40

50

60

J an Feb Mar Apr May J un J ul Aug Sep Oct Nov Dec

2003 2004

% YoY

0

5

10

15

20

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2003 2004

% YoY



Changing Pattern of Investment Growth

Jan-Feb Mar Apr May June Jul Aug Sep OctSecondary Industry (SI) 79 58 45 26 30 46 37 46 37 Mining 5 60 30 8 35 69 38 45 54 Manufacturing 78 72 48 23 24 41 34 47 32 Electricity, Gas & Water Production and Supply 61 47 40 46 53 52 46 45 50 Construction 93 74 63 1 3 32 41 42 7Petroleum, Coking & Nuclear Fuels Processing 26 151 164 124 156 116 119 100 73Communication, Computer & Other Electronic Eq 35 2 9 -3 17 101 84 137 15Electric Machinery and Instrument 170 93 96 32 -1 98 69 128 62Special Purpose Equipment 143 38 102 5 20 40 59 14 27Electricity & Heating 64 53 38 48 59 54 47 44 53Beverage Manufacturing 53 65 11 -3 -1 9 44 14 58Textile Industry 152 71 -2 -2 26 10 35 24 19Transportation Equipment 72 90 49 35 36 59 35 61 10Metal Products 136 127 167 16 28 47 34 55 67Ferrous Metal Mining, Smelting and Pressing 176 65 59 31 10 15 22 373 258Smelting & Pressing of Non Ferrous Metals 36 138 72 26 3 13 -7 67 -7Residential Building 49 21 25 23 22 24 24 28 31

Growth of fixed asset investment by industry (% YoY)



Core Inflation Is Set to Rise Quickly

While headline and non-food inflation are still moderate, they climbed from deflation 2 years ago The official rates may still underestimate inflation pressures because of price controls High input prices is likely to push inflation higher. Earlier analyses suggest that (1) 1% increase in raw material prices leads to 0.3% rise in CPI with time lags; (2) $10/barrel rise in oil prices pushes up CPI by 0.3-0.5% Rapid growth of wages not only pushes up costs of production but also strengthens consumer demand in the markets

Headline inflation likely peaking

Non-food CPI should grow further (%)


(2)

(1)

0

1

2

3

4

5

6

Jan-01

Apr J ul Oct J an-02



Apr J ul Oct

CPI (% YoY) CPI (% MoM)

%

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan-02 Apr Jul Oct J an-03 Apr Jul Oct J an-04 Apr Jul Oct

% YoY


Power Shortage Became a Nation-wide Problem

24 out of 31 provinces experience rationing of electricity consumption. Total shortage can be 3-6% of expected demand and net impact on GDP could be 0.3% The government introduced new schemes to ease the shortages, including increasing investment, usage management and price liberalization Stand-alone generators significantly reduce the impact of power shortages, but they at the same time raise cost of production and pollute the environment Power shortages would not disappear until 2006E

(10)

(5)

0

5

10

15

20

86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03

GDP Energy Consumption Electricity Consumption

% YoY

0

10

20

30

40

50

60

70

Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04

Fixed Asset Investment FAI in Power Industry

% YoY

Source: National Statistics Bureau, and Chinese Academy of Social Sciences.


Shortage of Migrant Labor in Coastal China

Is labor supply unlimited? Number of migrant laborers reached 98mn in November-2003 and has been growing by 5% yoy Underdeveloped labor market – lack of information, low wages, poor social welfare benefits and skill mismatch Some employers are already paying 20-30% more to attractive workers; and social welfare contributions could account for 40-50% of payrolls Implications: hurting corporate profits, boosting consumption and adding inflationary pressure

0

1

2

3

4

5

6

7

8

1995 1996 1997 1998 1999 2000 2001 2002 2003*

NAB Data CASS Data Registerred Unemployment Rate

%

Rising urban unemployment rate (%)

Source: National Statistics Bureau, and Chinese Academy of Social Sciences.


Beginning of Monetary Tightening

(with effect from) 23-Aug-96 23-Oct-97 25-Mar-98 1-Jul-98 7-Dec-98 10-Jun-99 25-Feb-02 29-Oct-046 months 9.18 7.65 7.02 6.57 6.12 5.58 5.04 5.221 year 10.08 8.64 7.92 6.93 6.39 5.85 5.31 5.581-3 years 10.98 9.36 9 7.11 6.66 5.94 5.49 5.763-5 years 11.7 9.9 9.72 7.65 7.2 6.03 5.58 5.85> 5 years 12.42 10.53 10.35 8.01 7.56 6.21 5.76 6.12

On 28 November 2004, PBOC announced changes to its interest rate policies

Ceiling for lending rates were removed for commercial banks (with the only exception of rural credit cooperatives) and deposit rates were allowed to float downward, but not upward

Base lending and deposit rates were raised, by 27bps for 1-year loans/deposits

Changing lending rates, August 1996 – Oct 2004 (%)

Source: People’s Bank of China and CEIC.


CNY May Appreciate At Least 25% in the Next 10 Years

10

30

50

70

90

0 10 20 30 40 50 60 70 80

GDP per capita, percent of U.S.

Exc

hang

e R

ate

rela

tive

to P

PP

(U

S=

100)

10

30

50

70

90

Korea 1960-1995Taiwan 1955-1995China 1980-2002Japan 1950-1975

1950

19751955

1995

1960

1980

2002

1995

GDP per capita and exchange rates relative to purchasing power parity at five-year intervals: Japan; Taiwan; Korea; and China

Source: Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 6.1, Center for International Comparisons at the University of Pennsylvania (CICUP), October 2002.; and IMF, April 2003 WEO Database .


Asia’s Growth Is Linked to One Another More Than the US

Business Cycle Concordance Based on GDP Growth Cycles

Last 10 Years (1Q93-1Q03)

Note: * Significant at the 10% level; ** Significant at the 5% level; *** Significant at the 1% levelSource: Citigroup calculations based on John McDermott and Alasdair Scott, “Concordance in Business Cycles” IMF Working Paper No. 00/37 (Washington DC: International Monetary Fund) 2000

Asia Pacific

HK ID KR MY PH SG TW TH US JPHK *** *** *** ** *** **ID ** ** *** * * **KR *** ** ** *** *** **MY *** ** *** ** **PH * ** *SG ** *TW ** **THUSJP


Strong intra-regional trade linkages

China and Intra-regional share in Asia Total Trade

Source: CEIC, Citigroup estimates.

11.2 11.5 12.1 13.0 12.9 13.1 14.6 16.4 19.0 18.8

25.9 26.3 26.4 25.5 26.6 27.4 26.727.7

28.4 27.4

17.4 16.2 14.9 13.3 14.1 14.8 13.8 13.218.0

13.1

45.5 46.1 46.6 48.2 46.4 44.7 44.9 42.734.5

40.7

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 Jan-Jul 04

China Asia-Pac ex China Japan Rest of the World


Long-term Asia FX forecasts show appreciation

Source: Citigroup estimates

Nominal Exchange Rate and Implied Real Exchange Rate Appreciation

Asia Pacific

2002 2003 2004 2005 2006 2007 2008CN lc vs. USD 8.28 8.28 8.28 8.07 7.67 7.21 6.70

Implied Appreciation 1.00 0.95 0.92 0.94 1.00 1.06 1.15HK lc vs. USD 7.80 7.80 7.78 7.80 7.80 7.80 7.80

Implied Appreciation 1.00 0.93 0.87 0.82 0.79 0.77 0.75IN lc vs. USD 48.40 47.20 45.90 46.00 45.08 44.18 42.85

Implied Appreciation 1.00 1.01 0.99 1.00 1.03 1.07 1.12ID lc vs. USD 9,313 8,466 8,892 8,942 8,827 8,832 9,025

Implied Appreciation 1.00 1.15 1.11 1.11 1.14 1.16 1.16KR lc vs. USD 1,255 1,195 1,160 1,120 1,050 1,000 950

Implied Appreciation 1.00 1.03 1.05 1.09 1.14 1.19 1.24MY lc vs. USD 3.80 3.80 3.80 3.77 3.68 3.50 3.32

Implied Appreciation 1.00 0.97 0.92 0.89 0.89 0.97 1.05PH lc vs. USD 51.60 54.50 56.00 57.40 56.83 55.69 54.02

Implied Appreciation 1.00 0.93 0.84 0.77 0.80 0.85 0.92SG lc vs. USD 1.79 1.75 1.70 1.64 1.57 1.52 1.48

Implied Appreciation 1.00 0.97 0.98 1.00 1.06 1.10 1.12TW lc vs. USD 34.55 34.60 33.80 33.12 31.47 29.74 28.25

Implied Appreciation 1.00 0.96 0.93 0.93 0.97 1.05 1.11TH lc vs. USD 42.96 41.50 40.58 39.21 38.43 37.66 36.53

Implied Appreciation 1.00 0.99 0.96 0.98 0.98 1.01 1.06


Asian Macro Forecast: Hurt by Oil

Source: Consensus Economics, Citigroup estimates

Asia Pacific

2006(% change) Citigroup Market Median Citigroup Market Median Citigroup

Asia-Pacific 7.2 7.1 6.3 6.2 6.4

China 9.4 9.2 8.5 8.0 8.0India 6.0 5.9 7.0 6.6 7.0

Asian NIEs 5.6 5.7 3.8 4.2 4.7Hong Kong 7.7 7.4 4.5 4.5 5.0Singapore 8.3 8.3 4.5 4.4 4.5South Korea 4.6 4.8 3.3 4.1 5.0Taiwan 5.8 5.8 4.1 4.2 4.0

SEA-5 5.8 5.5 5.1 5.0 5.3Indonesia 4.8 4.7 5.0 4.9 5.5Malaysia 7.0 7.1 5.0 5.3 5.5Philippines 6.0 5.2 4.3 4.2 4.5Thailand 6.2 6.1 5.7 5.6 5.2Vietnam 7.3 7.2 7.1 7.0 7.5

2004 2005GDP Forecasts


Tightening Did Not Solve the Fundamental Problem

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14

16

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

0

10

20

30

40

50

60

GDP Growth (%, LHS) TFP Contribution (%, RHS)

GDP growth and total factor productivity growth as a share of GDP growth (% YoY, %)

Source: National Statistics Bureau, CEIC and Citigroup estimates.


Capital Is Too Cheap!

Note: Borrowing costs for private companies are from survey by PBOC officials Xie Ping and Lu Lei and average return to capital of listed companies is from Citigroup. Source: Citigroup estimates.

Costs of capital and potential returns to capital in China (%)

0 2 4 6 8 10 12 14 16

Nominal GDP Growth (2Q04)

Nominal GDP Growth (Potential)

5-Year Government Bond Yield

1-Year Working Capital Loan Rate

Private Sector Actual Borrowing Costfrom Banks

Informal Financing Lending Rate

Average Return to Capital for ListedCompanies

%


Rebound of Nonperforming Loans

The government is accelerating its banking reforms. But are these sufficient?

Source: China Banking Regulatory Commission and Citigroup estimates.

23.0

17.8

13.3 13.4

26.5

20.4

15.6 15.7

0

5

10

15

20

25

30

End-2002 End-2003 Jun-04 Sep-04

Total SOCBs

%


Asian Trade Reorienting Through China

Share in Total US Imports

Source: CEIC, Citigroup

18.1 18.7 18.3 18.5 18.0 16.6 14.5 14.0 13.4 12.8 12.0 11.1 10.5 9.4 8.9

3.1 3.9 4.8 5.4 5.8 6.1 6.5 7.2 7.8 8.0 8.2 9.0 10.8 12.1 13.0

16.4 16.7 17.1 17.0 17.1 17.6 16.9 16.5 16.2 15.8 15.4 14.1 14.0 13.2 12.8

62.4 60.7 59.8 59.1 59.1 59.7 62.1 62.3 62.6 63.4 64.5 65.8 64.7 65.4 65.3

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Jan-Sep04

Japan China Asia ex China Rest of the World


Pattern of Tech Dependence Shifting

Sources: Citigroup calculations based on data provided by CEIC

Asia Pacific

Electronic Exports (% of Total Exports)

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20

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50

60

70

80

China Hong Kong Korea Malaysia Philippines Singapore Taiwan Thailand

Jan-Sep '99 Jan-Sep '04

Electronic Exports (% of GDP)

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40

50

60

China Hong Kong Korea Malaysia Philippines Singapore Taiwan Thailand

1999 2003


0

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1000

1500

2000

2500

3000

3500

4000

4500

Shan

ghai

Malay

sia

Beijin

g

Tian

jin

Zhejiang

Thailand

Guan

gdon

g

Jian

gsu

Fujia

n

Liao

ning

Shan

dong

Hube

i

Xinjiang

Philip

pine

s

Inne

r Mon

golia

Indo

nesia

Huna

n

Hena

n

Chon

gqing

Jian

gxi

Anhu

i

Sich

uan

Shaa

nxi

India

Vietna

m

Guizh

ou

China’s Regional Structure Likely to Remain Diversified

Source: Citigroup, China Statistical Yearbook and CEIC.

Domestic economic structure/costs will be diversified Cost advantages over some Asian economies are already quite limited

GDP per Capita (US$)


Education Still an Opportunity

0

5

10

15

20

25

30

35

CN HK IN ID KR MY PH SG TW TH JP US

Average year of schooling Percentage of population completed tertiary education

Years, % of Population

Educational Attainment of Population 25+, 2000

Source: Barro & Lee


Governance May Be a Key to Growth

Governance Indicator (Aggregate)

Note: Governance indicators are oriented so that higher values correspond to better outcomes, on an aggregate scale from –15 to 15. Aggregate include voice and accountability, political stability, government effectiveness, rule of law, regulatory quality and control of corruption indicators. Source: D. Kaufmann A. Kraay, and M. Mastruzzi (2003) • World Bank Policy Research Working Paper 3106

Aggregate Score

Average Percentile Rank

Aggregate Score

Average Percentile Rank

China -2.11 43.2 -1.42 46.8Hong Kong 7.30 82.5 7.09 82.1India -0.95 47.9 -0.87 47.5Indonesia -5.16 22.9 -1.94 42.3Korea (South) 3.80 71.4 3.17 73.0Malaysia 2.66 65.2 3.66 76.9Philippines -1.32 45.5 0.08 55.1Singapore 10.36 91.7 9.72 92.9Taiwan 5.34 77.7 5.15 81.1Thailand 1.64 61.0 1.08 61.0Vietnam -3.24 37.2 -2.67 36.5

2002 Estimates 1996 Estimates


China – Macroeconomic Forecasts

1998 1999 2000 2001 2002 2003 2004E 2005E 2006ERealReal GDP (% yoy) 7.8 7.1 8.0 7.3 8.0 9.3 9.4 8.5 8.0Domestic demand (% yoy) 8.6 8.5 9.7 9.0 10.0 11.9 11.1 9.2 8.1Real Consumption: Private (% yoy) 6.8 8.0 8.7 6.3 6.5 6.4 7.0 7.2 7.7Real Gross Fixed Capital Formation (% yoy) 10.0 7.1 9.6 12.4 14.3 20.8 17.0 12.0 9.0GDP (USD bn) 954 999 1,079 1,192 1,287 1,463 1,694 1,981 2,336GDP per capita (USD) 729 791 856 924 989 1,110 1,214 1,410 1,573Industrial output (% yoy) 8.8 8.9 11.4 9.9 12.6 17.0 16.5 12.0 8.5

External SectorExports (% yoy, US$) 0.6 6.0 27.8 6.8 22.4 34.6 35.0 25.0 16.0Imports (% yoy, US$) -1.5 18.2 35.8 8.2 21.2 39.8 40.0 30.0 22.0Trade balance (US$ bn) 43.6 29.2 24.1 22.6 30.4 25.5 13.7 -11.7 -58.7Current acount (% of GDP) 3.1 1.6 1.9 1.5 2.8 3.1 1.2 -0.2 -1.5International Reserves ex. Gold (US$ bn) 149 158 168 216 291 403 550 610 680Import cover (months) 10.8 10.0 8.1 9.5 10.7 11.8 11.3 10.9 0.0Currency/USD (period average) 8.28 8.28 8.28 8.28 8.28 8.28 8.28 8.11 7.71

Other6M lending rate (period average) 6.4 5.9 5.9 5.9 5.3 5.3 5.6 6.6 7.6Consumer prices (average, % yoy) -0.8 -1.4 0.4 0.7 -0.8 1.2 4.2 5.0 4.0Fiscal balance (% of GDP) -1.2 -2.1 -2.8 -2.6 -3.0 -2.5 -2.0 -1.5 -2.5



ANALYST CERTIFICATION I, Yiping Huang, hereby certify that all of the views expressed in this research report accurately reflect my personal views about any and all of the subject issuer(s) or securities. I also certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report.

Disclosure Appendix

china’s macroeconomic outlook: monetary tightening

Documents

6mar3 gdp

gross capital formation

growth of consumption

yoyfood cpi

medical caretraffic

net export

citigroup estimates

cultural articles