The Turn is Not Here

The official August data told a story of a weak and possibly still-weakening industrial sector but a still-healthy consumer economy. Although the CPI print complicates the continuing policyeasing story， we think Beijing will continue to roll out its moderate， easyas-she-goes mini-me stimulus over the next few months.

The official August data as below:

The main points in the data are the following:

Industrial production (IP) growth momentum remained slow. Year-on-year IP growth was 8.9% in August from 9.2% in July thanks to a base effect. Month-on-month (m/ m) seasonally adjusted (SA) IP growth seems to have stabilized at the uninspiring level of 0.69%. Moreover， the slower y/y IP growth trend looks set to continue into September.

Fixed asset investment (FAI) growth decelerated to 19.1% y/y in August (20.4% previously). Official infrastructure and real estate investment growth improved， but the sharp decline in manufacturing investment more than balanced it out.

In real terms， retail sales growth was unchanged in August at 12.1% y/y. Despite problems with the data， we believe this does indeed indicate that consumption and services growth is holding up better than industry.

Consumer price index (CPI) inflation picked up slightly to 2% y/y in August (from 1.8% in July)， driven mainly by vegetable prices that rose on bad weather over the summer. We do not think this is anything to worry about， though: non-food price inflation edged lower to 1.4% y/y in August(1.5% previously).

According to the data， we found the following features:

Light industry slowed more than heavy industry (Figure 1); this is important， as it reverses the trend of a few months ago and suggests that many sectors， not just steel and the other heavy sectors， are now facing a downturn.

Electricity production rose 2.7% y/y in August (2.1% previously)， as Figure 2 shows. If one puts aside concerns about the accuracy of this data， this suggests that industry has hit a very slow， but stable， rate of expansion.

Over on the investment side of the economy， cement production rose 8.7% y/y in August (6.1% previously)， while steel production slowed to 1.4% y/ y in August from 6.5% in July (Figure 2). If one is looking for signs of a truly mild rebound in infrastructure et al， we recommend watching cement. Unlike steel， it cannot be stored， and unlike the FAI numbers， it is far less susceptible to mis-reporting. Official FAI numbers for infrastructure and housing picked up a bit on a y/y basis (Figure 3)， but we treat these with scepticism. If cement production really is up-trending， that is a very positive sign.

The coming difficulty of CPI

China’s CPI inflation picked up slightly to 2% y/y in August from 1.8% in July (Figure 4). Food prices rose by 3.4% y/y in August (up from 2.4% previously) thanks to sharp increases in vegetable prices after bad weather. Vegetable prices rose 20% m/m in August， compared with a decline of 1% in July. But non-food price inflation edged lower to 1.4% y/y in August (1.5% previously). On an m/m seasonally adjusted annual rate (SAAR) basis， CPI rose by 1.7% in August on a three-month moving average (3mma)， firmly tracking our current 2% forecast for 2012.

We are more concerned about the recent landing and imminent takeoff of the pig cycle. Pork is the largest single component in the food part of the CPI basket， accounting for 9.4%， followed by grain (about 8.7%). Pork prices rose by 1% m/m in August， but this was the first rise since October 2011 (pork prices fell by an aggregate of 23% from October 2011 to July 2012). We believe the downtrend in pork prices is over. The pig-tofeedstuff ratio， at 5.7 in August (Figure 5)， is now in loss-making territory (the key level is 6.0)， meaning that farmers will now be exiting the sector. These things take a while to feed through， but we suspect that strong pork price increases are now being roasted into CPI for Q2-2013.

As an aside， we note that the 2% August CPI print could easily have come in higher (our forecast was 2.3%). The average food price rose by 5.7% m/m in August， according to the National Bureau of Statistics (NBS). However， this translated into only a modest 1.5% m/m growth in the CPI food index. Figure 7 compares m/m growth in the average food price and the CPI food index (both are monitored and released by the NBS). As one can see， the gap was unusually large in August (large gaps in January/ February are caused by the Chinese New Year holiday).

Higher y/y CPI over the coming months will complicate monetary policy decisions — and give the People’s Bank of China (PBoC) ammunition to support its apparent view that benchmark rates do not need to go lower.

Conclusion

Overall， growth momentum stayed weak in August， and a quick rebound is hard to imagine. As we have highlighted there are some sectors that are bearing the brunt of the slowdown. And the economy has problems with rising receivables and high inventories — and most importantly， deterioration in confidence， which is feeding through to weak manufacturing investment. These are important drags on the economy — and bear watching carefully.

We also note， though， that the consumption/services space so far looks fairly resilient， the labour market is apparently healthy， and leading indicators such as credit growth have ticked up， partly as a result of policy easing， which began in Q1-2012. That said， there are signs (for example， in computers， snacks， and Hong Kong retail sales) that consumption is decelerating.

We believe that further policy easing is still on the cards. Although the PBoC appears to believe that benchmark rates are already low， that they have done “their bit” that the economy has stabilized， and that lower benchmark rates would re-trigger an investment-inflation cycle. One can understand their caution.

The problem is that real lending rates are high — a benchmark loan at 6% and PPI at -3% suggests a real rate of 9%. Our view is that if the State Council wants to boost growth in the short term (September-October) in the face of slower data， it may well still order the PBoC to cut rates. The PBoC’s preference is RRR cuts， it appears.

So when will things pick up? Once we saw the mini-me stimulus begin back in Q2-2012， we took the view that the effects would show up in September， with growth stabilizing and then gradually recovering. Here we are in September， and it is still a very mixed picture — and our expected moderate recovery looks to be delayed. We are currently reviewing our 2012-13 GDP forecasts. We broadly see the mini-me stimulus continuing and that activity will remain slow in the coming two to three months， with possibly more movement in policy after October. We take comfort from overall credit growth though (Figure 7)， and still believe this points to a mild recovery in the near future， clear by Q1-2013.