IHS Global Insight Perspective
The Chinese economy continued to ride on momentum started in the second quarter of last year, and has accentuated a V-shaped recovery path with a strong first quarter this year.
While the strong first-quarter growth has to a large extent reflected a quite favourable base effect, the stabilisation of external demand has also played a significant role in propping up growth. Additionally, the structure of growth is also improving, as growth starts getting more support from non-stimulus sources.
The first quarter could turn out to be the best quarter for China this year, featuring high growth and low inflation. But the picture will become increasingly mixed going forward, as inflation is expected to tick up gradually and growth will also slow down in coming quarters.
Growth Accelerates on Favourable Base Effect
China's GDP growth accelerated to 11.9% in year-on-year (y/y) terms in the first quarter (Q1), from 10.7% y/y in the final quarter of 2009. The pace of growth also exceeded the 10.6% y/y growth recorded in the first quarter of the pre-crisis 2008, and represented a record high since the fourth quarter of 2007. Much of the momentum has come from a favourable base effect, as China's growth slowed to 6.2% y/y in the corresponding quarter of last year, a record low. Industrial added value, an indicator closely related to GDP, soared 19.6% y/y in the first quarter, accelerating from 11% y/y growth for the whole of 2009, also helped by a positive base effect—China's industrial added value expanded only 5.1% y/y in the first quarter of 2009. Leading the industrial growth was the heavy industrial sector, which recorded 22.1% y/y expansion, compared with 14.1% y/y for the light industries, on the back of rising manufactured goods prices and rebounding demand. Reflecting continued recovery in external demand, the export delivery value of above-scale firms increased 25.2% y/y in the first quarter.
Growth Gains Support Beyond Investment
China's growth is now getting support from sources beyond investment, with continued steady rebound of exports, moderating fixed-asset investment (FAI) expansion and still robust retail sales growth. Capital formation's contribution to GDP growth rate dipped to 6.9 percentage points, down from 8 percentage points in 2009. Exports' contribution to GDP growth was still negative, -1.2 percentage points, though still a marked improvement compared with its 3.9 percentage point negative contribution to GDP growth in 2009 overall. Final consumption contributed 6.2 percentage points to China's GDP growth in the first quarter, compared with 4.6 percentage points in 2009.
In the first quarter, China's exports went up 28.7% y/y and its imports surged 64.6% y/y—partly reflecting the strong recovery of domestic demand and partly the soaring prices of commodities. While China recorded its first monthly trade deficit in six years, US$7.24 billion in March, the country remained in surplus in the first quarter of this year. The first-quarter surplus, totalling US$14.5 billion, represented a fall of 76.7% y/y.
Nominal FAI growth continued to moderate in the first quarter, with urban FAI growth slowing to 25.6% y/y in the first quarter, from 26.6% y/y in the first two months. This marked the fifth straight month of deceleration in FAI growth, after the investment growth rate peaked at a high of 33.3% y/y in September last year—a record high since May 2004. The deceleration of FAI growth in real terms is even more dramatic, as real FAI growth in the first quarter will be only slightly above 20%, down sharply nearly 50% at last year's peak. Railway transport investment, where a big portion of stimulus money has been funnelled into, showed only a modest increase of 16.4% y/y, sharply down from a stunning 67.5% y/y growth in 2009. However, real estate investment has picked up, accelerating to 35.1% y/y in the first quarter from only 4% in the first quarter of last year.
Retail sales, a rough proxy of domestic consumer demand, advanced 17.9% y/y in the first quarter, accelerating by 2.9 percentage points from the corresponding period of last year and by 2.4 percentage points from 2009 overall. While attesting to the relative robustness of domestic consumer demand as well as strong government spending, the stronger retail sales figure has also been inflated by the higher inflation rate in the first quarter.
Inflation Eases, Money Growth Slows
Consumer price inflation pulled back slightly in March to 2.4% y/y, from February's 2.7% y/y increase. For the first quarter, consumer price index (CPI) gained by a modest 2.2% y/y, still much lower than the inflation-control target of 3%. Non-food inflation was also much more tamed, as non-food CPI edged up only 0.8% y/y in the first quarter. Nevertheless, producer price inflation is accelerating, hitting 5.9% y/y in March, a record high since November 2008, driven by a sharp rebound in production materials prices.
On the money supply side, data released by the central bank earlier this week shows that China's money and loan growth continued to slow, and by a larger clip, in March, as the Chinese central bank steps up efforts to rein in lending growth and drain liquidity from the market following a brief resurgence of credit binge in January. Broad money supply, M2, increased 22.5% y/y as of the end of March, down by 3.03 percentage points from growth recorded at the end of February and down by 5.18 percentage points from the end of last year. New renminbi loans in March stood at 510.7 billion yuan (US$74.83 billion), down from 700 billion yuan in February—an amount almost halved from the 1.39 trillion yuan in new loans made in January. For the first quarter, total new renminbi lending hit 2.6 trillion yuan, dramatically down from 4.6 trillion yuan recorded in the corresponding period of last year.
Outlook and Implications
The first quarter could turn out to be the best quarter of this year for China, featuring high growth and low consumer price inflation—largely thanks to the quite favourable base effect for GDP and prices. Going forward, the country's macroeconomic picture will become increasingly mixed, with slower y/y growth expected in the coming quarters and inflation likely to tick up higher. Nevertheless, there are many positive developments lately, especially when it comes to the structure of growth. A uni-dimensional growth trend seen in a greater part of last year is now replaced by multi-dimensional growth, thanks to continued recovery of the exports sector.
Partial stimulus withdrawal has resumed in the latter part of the first quarter. After a surge of new loans in January, loan increase slowed in the subsequent months and new loans in the first quarter were 44% lower than the same period a year earlier. Reflecting the policy pullback, FAI in real terms has moderated. However, rising industrial profit could help mitigate the impact of stimulus pullback. With corporate retained earnings being a major source of funding for China's investment expenditures, improved profits could provide support for investment spending as the government gradually withdraws stimulus spending.
On the external front, trade surplus narrowed in the first quarter—nearly 77% lower than a year ago. But trade surplus in real terms narrowed to a lesser degree, as the smaller nominal trade surplus—caused by surging imports—was partially due to high import prices, particularly commodities prices. The recent surge in imports should dissipate in the coming months, as commodity price inflation is expected to ease. Export demand rebound, on the other hand, has been much steadier. As the global economy continues to recover, exports should be able to maintain double-digit growth for the remainder of 2010.
The recent surge in imports, which are expected to be transitory, will not materially alter Beijing's renminbi policy. IHS Global Insight still expects the renminbi to resume appreciation around mid-2010, if not sooner. The renminbi move, however, could push back the expected interest rate hike by the PBoC, as higher interest rates in a fast growing economy will probably induce even larger hot money inflows playing the one-way bet offered by a steadily appreciating renminbi.We maintain our view that policy tightening/stimulus withdraw will be gradual. Other than in property prices, inflation in the wider Chinese economy has yet to turn into a major threat. This will allow the government to remain focused on economic growth, and affords room for a very steady and measured stimulus policy pullback.