By Win Thin
The weak November HSBC PMI for China has added to market bearishness. This is not the official PMI, and so we thought it would be interesting to see how the two manufacturing PMIs correlate with each other and with overall industrial production. Going back to January 2006, we find that the HSBC and official PMIs have a correlation of .80, suggesting that despite the measurement differences, the two move together pretty closely. We then ran correlations between each PMI series and IP growth in China, and found that they had similar magnitudes with official PMI at .657 and HSBC PMI at .670. We do note that while the HSBC measure has been below 50 for 4 of the 5 past months, the official PMI has yet to fall below 50, but it was reported at 50.4 in October, the lowest since February 2009. A further drop in the official PMI below 50 seems hard to avoid.
Slowing in the Chinese economy is inevitable given the deteriorating external environment as well as PBOC tightening measures taken in 2010-2011. GDP growth slowed to 9.1% y/y in Q3 from 9.5% y/y in Q2, and while this was the slowest since Q3 09, we don’t see a hard landing at this juncture. IP rose 13.2% y/y in October, down from the peaks around 15% y/y in mid-2011 and 18-19% y/y in early 2010. This slowing appears to be largely export-driven, as retail sales remain buoyant at 17% y/y in October, slowing only marginally from 20% peak rates in early 2011. Export growth has eased steadily this year to 16% y/y in October vs. 30-40% y/y in 2010-2011, while import growth has slowed over the course of 2011 to 20-30% y/y from 30-40% in 2010. Of course, with external risks rising it is not surprising that we have already seen the PBOC undertake some targeted easing in recent months, including this week’s cut in reserve requirements for over 20 rural cooperatives.
We think it is only a matter of time before we see broadbased easing in China, most likely in early 2012. Note that China tightened policy in 2006-2007 and was engineering a soft landing until the financial crisis hit in 2008, when growth slowed sharply. This led to a quick reversal in direction and aggressive easing from September-December 2008. Over those four months, reserve requirements were cut 200 bp and lending rates were cut 216 bp, while fiscal stimulus ended up being the largest in the world as a share of GDP. GDP growth slowed to a cycle low of 6.2% y/y in Q1 09 before accelerating back to double digits in response to stimulus. Near-term, we think China has the means and the will to fend off a hard landing, but acknowledge that China is by no means immune to global developments, and will find it harder and harder to fend off the growth headwinds.
Slowing China growth is already having knock-on effects for much of Asia, with Singapore, Taiwan, Korea, and others posting significantly slower export growth in recent months. As we’ve pointed out before, China is very important for EM. We have identified those countries in Asia that are most tied to China and Hong Kong in terms of exports and the list is worth repeating in light of the recent slowdown in China imports. We group the mainland and Hong Kong together, as Hong Kong often serves as an intermediary for trade between the mainland and the rest of the world, particularly Taiwan. China/HK is the number one export market for Korea (30%), the Philippines (16%), Malaysia (17%), Thailand (17%), Singapore (21%), and Taiwan (40%). Indonesia’s share is on the lower end (12%), as are India (10%), Pakistan (8%), and Vietnam (10%), so these countries may be a bit more insulated to the China slowdown story. Beyond Asia EM, Chile and Peru stand out due to China’s commodity imports, with China’s share of total exports 24% and 16%, respectively. Looking beyond EM, we note that Australia’s share of total exports going to China/HK is around 23%, much higher than New Zealand’s share at 11%. China/HK accounts for 24% of Japan’s total exports.
With regards to the currency, a harder than desired landing would most likely lead to a halt in CNY appreciation, like we saw from mid-2008 to mid-2010. Under the soft landing scenario, we think it will continue to appreciate from 3-5% per annum. The US is likely to continue ratcheting up the pressure on China for more currency flexibility as we go into an election year, but we think China policy-makers will do what’s best for China, not for the US. That is what allowed CNY to be one of the best performers in EM during the 2008-2009, and we look for similar outperformance going forward if the euro zone crisis deteriorates. Bottom line: we think chances of a harder landing have increased, but feel comfortable that policy-makers will react aggressively as needed to prevent a very hard landing in 2012.