China Inflation May Let Wen Intensify Growth Efforts
Comment of the Day

July 09 2012

Commentary by David Fuller

China Inflation May Let Wen Intensify Growth Efforts

This is an interesting and topical article from Bloomberg. Here is the opening:
China's inflation eased to a 29-month low and Premier Wen Jiabao said the government will intensify its response to the economy's slowdown as growth wanes in Asian neighbors from Japan to Vietnam.

The consumer price index (MXAP) rose 2.2 percent in June from a year earlier, the government said today in Beijing. Japan's May machinery orders fell the most since 2001, while Hong Kongand Vietnam signaled growth may fall short of official forecasts.

Nomura Holdings Inc. said China will boost public investment and Credit Agricole CIB forecast cuts in taxes and banks' reserve requirements after Wen was reported as saying downward pressure on the economy is still "relatively large." Asian nations are becoming increasingly dependent on China to drive growth as Europe's deepening debt turmoil crimps exports and the U.S. labor market slows.

"Inflation is dead and growth is by far the main concern in Asia," said Tim Condon, chief Asia economist at ING Financial Markets in Singapore, who previously worked at the World Bank.

The MSCI Asia Pacific Index of stocks fell 1.4 percent at 4:14 p.m. in Tokyo, set for the biggest drop in a month. The gauge has declined about 15 percent in the past year. China's benchmark Shanghai Composite Index dropped 2.4 percent, the largest decline since June 4.

China's inflation compared with the 2.3 percent median estimate in a Bloomberg News survey of 32 analysts. Producer prices dropped 2.1 percent, versus the median forecast for a 2 percent fall. Consumer-price gains have now stayed below Wen's 4 percent target for five months.

Rate Reduction

The government lowered benchmark interest rates on July 5 for the second time in a month, adding to the first reduction since 2008 and three cuts in banks' reserve requirements starting in November. At the same time, Wen said officials will "unswervingly" continue property controls and prevent home prices from rebounding, the official Xinhua News Agency reported yesterday.

China will probably make one more quarter-point cut in interest rates this year and two more half-point reductions in the reserve-requirement ratio, according to median estimates in Bloomberg News surveys conducted July 5-9.

David Fuller's view A perennial hazard for all governments is that they spend too much time fighting the last war, not least in terms of inflationary or deflationary risks. Governments are reactive by nature, and having waged one economic battle, they are understandably wary of changing course too quickly. Problems of timing are often compounded because officials have little choice but to rely on historic data when assessing prospects, and then on eventually changing direction they implement policies which may take weeks or even months to have any effect.

In the current economic slowdown, I have previously mentioned my concern that both China and India were not providing renewed monetary stimulus quickly enough. China is the main engine for global economic growth in this century and preoccupied with its own property bubble, now deflating rapidly, it appears to have underestimated economic slowdowns in its two biggest export markets, Europe and the USA.

China now recognises the problem, evidenced by two recent interest rate cuts within a month and Premier Wen Jiabao's comments above.

However, to the extent that the stock market is a litmus test for economic sentiment, we have yet to see it improve, as you can see from today's latest downward step by the Shanghai A-Shares Index (daily & weekly), which is now testing its late-Dec to early-Jan lows. While these are likely to offer some support, A-Shares will need to break the orderly step-sequence decline clearly evident on the daily chart above to indicate that demand is regaining the upper hand. Meanwhile, the Index is a long way from a rally back above its decline 200-day MA and the two previous rally highs near 2600, which remains necessary to indicate potential base completion and medium-term recovery scope.

As sentiment towards China's stock market continues to deteriorate in line with the overall downward trend, valuations continue to improve. China's A-Shares PER remain near historic lows and its Yield is now testing its 4Q 2008 high. With the European and US economies weak, China will need to rely on its domestic economy to strengthen GDP growth. This prospect is reflected by the better relative strength shown by the following sectors: Consumer Staples, Healthcare, Information Technology and Utilities.

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