China Expectation by riteshbhansali


                                                                   UOB Economic Projections     2010      2011    2012F    2013F
                                                                   GDP                           10.4     9.2       8.0      8.3
                                                                   CPI (average, y/y %)          3.3      5.4       3.0      2.3
                                                                   Current account (% of GDP)    5.0      2.7       2.2      1.8
                                                                   Fiscal balance (% of GDP)     -1.7     -1.9     -2.0     -1.4

  ƒ With RMB deemed to be at fair value, more volatility and less appreciation is in store for the currency, as it moves toward
    full convertibility which would still be years away. For 2012, we have shaved off further our remaining expectations for
    the RMB, by revising down our end-year forecast to 6.30/USD, from our earlier (already lowered) call of 6.22.

  ƒ Recent data from China showed some stabilization, but overall a slowdown is apparent. These data affirmed our view
    that headline growth is likely to trough in 2Q12/3Q12. We maintain our call for China’s GDP growth at 8% for 2012.

  ƒ Monetary policy is poised to remain accommodative, though the pace remains measured. Post the 7 June move, we look
    for another 2 more symmetric interest rate cuts of 25bps each before end of 2012, as well as similar number of reserve
    ratio cuts.

RMB In Sideways Mode                                               ation and undervaluation. US Treasury Sec Geithner moot-
Appreciation Trend broken                                          ed at the G20 summit in South Korea in Oct 2010 that a cur-
Since early 2012, the RMB appreciation trend from the pri-         rent account surplus of 4% of GDP would be an indicator,
or two years has essentially been broken, a reminiscence           meaning that a higher surplus suggests an undervalued
of the pattern back in 2009/early 2010 during the global           currency.
financial crisis, as shown in the chart. One factor driving
the current RMB behavior is the downbeat view for China’s          In this respect, China’s current account has fallen below
and global growth prospects. Another factor is that China’s        that threshold, to 2.8% of GDP in 2011, compared to peak
policymakers have expressed their view that the RMB is             of 10.1% in 2007, as the RMB NEER appreciated more than
near its fair value.                                               15%, and nearly 20% against USD during the 2007-2011
                                                                   period. As such, the end-2011 USD/RMB value of 6.2950
However, what is the fair value of the currency? Obviously         seems to have taken on the role of “fair value” yardstick.
there are many ways to measure the degree of overvalu-             This is reflected in the daily setting of the midpoints this
                                                                   year, which have been confined within +/-1% around
                                                                   6.2950. With the widening of the daily onshore USD/RMB
                   China: USD/RMB Trend
                                                                   trading band to 1% from 0.5% previously, starting from 16
                                                                   Apr, spot trading of the RMB has also diverged increasingly
    7.0                                                            from the fixings, given the emphasis of PBoC on more “flex-
    6.9                                                            ibility” for the RMB.
                                                                   In short, there is more volatility embedded into the RMB
                                                                   trading and less appreciation especially with the develop-
                                                                   ments since the beginning of the 2012 (namely, widen-
                                                                   ing of trading bands, internationalization of RMB). On the
    6.4                                                            current account front, the days of high balances are not
                          Appreciation Trend
    6.3                                                            likely to return anytime soon given the uncertain global
                         Broken In Early 2012
    6.2                                                            environment and increased emphasis on China’s domestic
      Jun 08    May 09     Apr 10    Mar 11     Feb 12             demand drivers. This means that going forward, the RMB is
                                                                   unlikely to see a steady, annual appreciation pace of 3-5%
  Source: Bloomberg, UOB Economic-Treasury Research’s Estimate     back in 2005-2011. Instead, a period of significantly smaller

                                                                                                Quarterly Global Outlook 3Q2012    29
                                                                                                UOB Economic-Treasury Research

appreciation and more volatile moves should be expected,          For 2012, we expect China’s inflation to average around
ahead of the full convertibility of the currency in the years     3%, down from our previous forecast of 3.3%. This would
ahead. For 2012, we have shaved off further our remaining         allow the PBoC more room to manoeuvre in the policy rate
expectations for the RMB, by revising down our end-year           space. Indeed, PBoC did just that on 7 June with its first in-
forecast to 6.30/USD, from our earlier (already lowered) call     terest rate cut since 2008. We look for another 2 more sym-
of 6.22. For end-2013, our call is pared back as well, to 6.21/   metric interest rate cuts of 25bps each before end of 2012:
USD from 6.00 earlier.                                            one each in 3Q12 and 4Q12. This would bring the key 12M
                                                                  lending rate down to 5.81% from 6.31% currently, and the
Growth In A Sluggish Phase                                        12M depo rate to 2.75%.
But Not In “Hard Landing”
Recent data from China showed some stabilization, but             However, the change in interest rate floors and ceilings an-
overall a slowdown is apparent. These data affirmed our           nounced at the previous interest rate cut (7 June) could in
view that headline growth is likely to trough in 2Q12/3Q12,       principle result in lower lending rate and higher deposit
just as accommodative policy measures are beginning to            rate than the official rates. To recap, PBoC took a step for-
take shape, the risks remain on the downside as the Euro-         ward with interest rate liberalization measures, allowing
zone sovereign debt crisis remains unresolved.                    banks to offer a discount of up to 20% for lending rates (vs.
                                                                  previous maximum discount of 10%) and also a maximum
To recap, industrial production rose 9.6%y/y in May vs.           premium of 10% for deposit rates (from no premium al-
9.3% in Apr, while fixed asset investment rose 20.1%y/y           lowed prior to this date).
YTD compared to 20.2%y/y YTD in Apr. Retail sales gained
13.8%y/y vs. 14.1% in Apr (in particular, sales of household                       China: CPI And Components
electronics increased by only 0.5%y/y in May from 7.7%y/y
in Apr, underlining the urgency to introduce a stimulus                             Non-food CPI
                                                                                    Headline CPI
plan in mid-May to encourage energy-saving home ap-                                 Food CPI
pliances). Monetary data show shows improvements as                   25
well, with M2 growth rising 13.2%y/y in May, from 12.8%                                                  y/y% change
in Apr, while new RMB loans increased by RMB793.2bnin
May from RMB681.8 bn in Apr. This brings YTD new RMB                  15
loans to RMB3.9tn, which could still fall short of target of
RMB8-8.5tn for the year.
Easing inflationary pressures are another characteristic in
May, slowing sharply to 3%y/y from 3.4% in Apr, the lowest
rate since May 2010. In the months ahead, China’s inflation            -5
is likely to head lower, partly due to the high base effect             Jan 07     May 08      Sep 09     Jan 11    May 12
(last peak at 6.5% in July last year), but more importantly
slowing growth momentum both domestic and globally is               Source: CEIC, UOB Economic-Treasury Research
taking much steam out of price pressures.

                                                                                 China: Reserve Requirement Ratio
                China: New RMB Loans (Monthly)
                                                                                    Headline RRR
                                                                                    Small & Medium Institutions
   1200.0                                                            24.0
               m/m change, RMB bn                                    22.0    %
   1000.0                                                            20.0
    800.0                                                            18.0
    600.0                                                            14.0
                                                                                                          UOB’s Forecast
    400.0                                                            12.0
    200.0                                                             8.0
      0.0                                                             6.0
            Jan 11     Jun 11         Nov 11       Apr 12               Jan 05 Apr 06 Jul 07 Oct 08 Jan 10 Apr 11 Jul 12

  Source: CEIC, UOB Economic-Treasury Research’s Estimate           Source: CEIC, UOB Economic-Treasury Research

    Quarterly Global Outlook 3Q2012
30 UOB Economic-Treasury Research
For instance, with the benchmark lending rate cut to 6.31%       be towards the 15.50% low prevailing during the 2008/9
from 6.56%, the lowest rate a bank could charge for its          Global Financial Crisis. As such we expect PBoC to cut at
loans falls to 5.05% with the maximum 20% discount (It           least another 50bps for its RRR in the next few months.
should be noted that the bulk of bank loans in China are
granted at a premium, rather than at a discount). The actu-      With China starting to loosen even on interest rate front
al deposit rate in turn could rise to 3.58% theoretically with   and also putting on selective fiscal measures, risks of a
the maximum premium of 10%, which is actually higher             “hard landing” in China have gone down significantly in
than the prevailing benchmark rate of 3.50% prior to the 7       the next 6-12 month horizon. We continue to hold on the
June announcement.                                               view for a soft landing scenario in China. Economic activi-
                                                                 ties are likely to trough in 2Q12 as we originally envisaged,
As for China’s bank reserve requirement ratio (RRR), PBoC        at around 7.6%y/y for the headline GDP figure from 8.1%
last cut the ratio on 12 May, its third for the current cycle,   in 1Q12, before rebounding in the second half to above
to 20.0% for large banks. While the RRR has been edging          8%. For the full year we continue to maintain China’s GDP
down since late 2011 from its historic highs of 21.50%, it re-   growth forecast at 8%. China will release its 2Q12 GDP re-
mains at elevated levels currently in view of a moderating       port on 13 July morning.
environment. A more “appropriate” level for the RRR should

                                                                                            Quarterly Global Outlook 3Q2012   31
                                                                                            UOB Economic-Treasury Research

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