China Data Stronger Than Expected, PBOC Must Move More Aggressively
By Win Thin
China data came in stronger than expected, and supports the view that PBOC is moving behind the curve with its gradualist approach and that it needs to get more aggressive. Q1 11 GDP growth slowed slightly to 9.7% y/y from 9.8% y/y in Q4 and 9.6% y/y Q3, but was better than the expected 9.4% y/y. CPI inflation accelerated to 5.4% y/y vs. 4.9% in January and February and 5.2% y/y expected and is a new peak for the cycle. Retail sales accelerated to 16.3% y/y in March vs. 15.8% y/y so overall, the robust real economic backdrop and rising inflation suggests that further tightening will be seen, perhaps matching the path seen in 2006-2007 or even exceeding it. So far, we have seen 100 bp of lending rate hikes that started in October 2010 and 450 bp of reserve requirement hikes that started in January 2010. During the previous tightening cycle, hikes were 189 bp and 1000 bp, respectively.
Given that the mainland economy remains very strong, we would characterize PBOC policy as still moderately accommodative and behind the curve, and suggest that another 75-100 bp of rate hikes and 550 bp of reserve requirement hikes at least could be seen in 2011, with risk to the upside in terms of tightening potential. Fears of a hard landing will surely rise, but we do think that China policy-makers still have time to set things right but action is needed soon. Real lending rate remains at an ultra-low 0.7% in March, much too low for this stage of the business cycle.
We also think that greater currency strength will be allowed in 2011 in order to be part of the adjustment process. 12-month NDFs are pricing in only 2.4% appreciation over the next year, and it will clearly have to be more than that. Actual y/y appreciation as of April 14 is 4.5%, and we just can’t see why they would slow the pace given continued strength in the economy and high price pressures. We’ve been looking for 5% over the next year, but the pace could easily exceed that. Lastly, we expect more unorthodox measures such as price controls, as policy-makers are most likely very wary of encouraging further inflows of hot money with orthodox rate hikes. It was interesting that Q1 foreign reserves jumped $197 bln, virtually the same pace as the $199 bln gain in Q4 despite the trade balance moving into a deficit of -$720 mln in Q1 vs. a surplus of $63 bln in Q4. We suspect part of that disparity is due to hot money inflows.