Forecast Revisions 2012-13

We have revised down our 2012 China real GDP growth forecast to 8.5% from 10%， and our forecast for 2013 to 8.5%. There are two main reasons for our call. Inflationhas remained more elevated and domestic growth momentum has slowed moregradually in 2011 than we forecast. This has delayed the turn in policy – China’s monetary policy was not loosened in Q3-2011， as we expected – and thus also the turn in the economic cycle. That said， momentum has clearly been lost in manufacturing growth， and CPI inflation has now peaked， we believe.

With CPI inflation hit 4.5% y/y in December， 2011， we believe moderate credit loosening could take place in Q4-2011-Q1-2012. The delay in the turn of the cycle means that domestic growth in H1-2012 will be slower than originally forecast. We look for China’s growth momentum to run at around 8% during Q4-2011-Q1-2012 before picking up moderately in 1-2012. Chart 1 shows the q/q rates of annualized GDP growth.

The second factor is the slowdown of the global economy in H2-2011 and the deterioration in sentiment associated with the European sovereign debt crisis. Our forecasts are predicated on the United States’ economy growing 2% and Europe’s economy growing 1.5% in 2012. We still believe that both regions will avoid outright recession， but there are clearly downside risks if European policy makers do not achieve a breakthrough.

Where growth will come from in 2012

* Investment. In future notes， we will be outlining our detailed views on the 2012-13 investment cycle. For today， we note that we expect fixed capital formation to grow 9% in real terms in 2012， after 11% in 2011. Construction in the commercial real estate sector will clearly slow， but social housing construction has the potential to take up some of the slack – as long as the central government is willing to finance these projects. At the same time， manufacturing investment growth will likely continue， given continued consumer demand and positive exports.

* Consumption. We believe that domestic consumption will hold up well in 2012， assuming no big hit from an external shock. Income growth in 2011 has been generally strong， bolstering China’s emerging middle class. With inflation partly controlled and moderate house price deflation expected (we look for national prices to fall 5-10% over the next six months)， we believe consumption should be positively supported.

* Government. We do not expect an explicit stimulative fiscal policy in 2012. However， the authorities are likely to respond to any dramatic slowdown in investment activity by authorising more projects – social housing， water irrigation improvement and so on. There is clearly an issue with funding such projects， given the alreadyhigh leverage levels of local government investment vehicles (LGIVs). We hope for more fiscal transfers to such projects. However， if necessary， the banks will likely be asked for their support.

* Exports. As we explored recently， we estimate some 12% of the growth in demand for China’s goods and services came from overseas in 2011. Before the crisis， that ratio was around 20%. On current forecasts， we look to 7% export growth for China in 2012， which should generate about 1ppt of the 8.5% headline GDP growth in 2012. Calculated from the expenditure GDP side of the national accounts， this would translate into a negative contribution to growth from‘net exports (Chart 2)， even if， as explained above， exports themselves still contribute to growth. We revise down our current account forecast for 2012 to 2.3% of GDP from 3.4%， suggesting that appreciation pressures are weakening.

* Inflation. With the sluggish global growth environment， imported inflation – particularly crude oil， the biggest import – should disappear over the next 3-6 months. The pig cycle should turn in Q1-2012， and although there is uncertainty about the extent of the supply response from household farmers， we do look for absolute declines in pork prices from Q2-2012. Pork was responsible for 1.4ppt of CPI inflation in August， 2011 and thus could subtract from the headline when prices turn. We forecast CPI inflation at 3.2% on average in 2012， and show the trajectory in Chart 3. We assume flat global oil prices in 2012， declining pork prices and a big base effect for much of the year.

* Interest rates. Facing weaker growth， we push back our interest rate hike forecasts into Q1-2013 (we previously looked for two hikes in H2-2012). An ideal monetary policy for 2012 would be a larger official loan quota (some CNY 9trn)， alongside higher interest rates. This would allow companies to access credit at more reasonable rates. But we doubt such a mixed monetary policy is possible.

* Currency. We believe that the pace of CNY appreciation will likely slow， from around 5.5% in 2011 to some 3-4% in 2012.

(Authors: from Standard Chartered Bank China)