| On the Ground |

http://research.standardchartered.com
Analysts
Li Wei, +86 21 6168 5017 Stephen Green, +86 21 6168 5018 Judy H Zhu, +86 21 6168 5016
Standard Chartered Bank (China) Limited Standard Chartered Bank (China) Limited Standard Chartered Bank (China) Limited
Economist Head of Research, China Commodity Analyst
Li.Wei-CN@sc.com Stephen.Green@sc.com Judy.Hui-Zhu@sc.com

China – The end of the ‘V’

08:00 GMT 11 August 2009

July data suggests that the recovery continues but is losing some momentum,
as expected
Official policy stance remains unchanged, though fine-tuning, especially of
monetary policy, is expected in the next few months
Some weakness in some commodity imports appearing

Today’s avalanche of China data suggests that the economic recovery is solid, but that the momentum ebbed
in July. What was a V-shaped recovery now seems to be experiencing a little gravitational pull. A number of
indicators – industrial and electricity production as well as fixed asset investment – showed either flat or
slightly weaker year-on-year growth in July. New bank loans came in at only CNY 355.9bn (USD 52bn), well
below June’s CNY 1.53trn; as we explain below, this lending went heavily to households rather than
corporates (see Table 1). The slightly weaker-than-expected data means an even smaller chance of an
imminent change in macro policy and lends weight to those who argue that it is too early to tighten. Having
seen the data early, Premier Wen Jiabao restated at the weekend that the goal was to maintain a proactive
fiscal policy and a moderately loose monetary policy.

Table 1: China’s July data

Growth, y/y July-09 June-09 H1-09 2008 average
CPI -1.8% -1.7% -1.1% 5.9%
PPI -8.2% -7.8% -5.9% 6.9%
M2* 28.42% 28.46% 21.14% 16.67%
FAI, YTD 32.9% 35.3% 35.3% 26.1%
Industrial value added 10.8% 10.7% 7.0% 12.9%
Retail sales 15.2% 15.0% 15% 21.6%
Exports -23.0% -21.4% -21.7% 17.2%
Imports -14.9% -13.2% -25.4% 18.5%
Trade surplus USD 10.6bn USD 8.2bn USD 96.9bn USD 295.8bn
* M2 H1-09 is average of month-end data for the six months of H1-09
Sources: NBS, Customs, PBoC, CEIC

Inflation expectations are not an immediate threat

Prices are stable overall, but are of course a lagging indicator of demand. The consumer price index (CPI) fell
by 1.8% y/y in July, compared with a fall of 1.7% y/y in June. The producer price index (PPI) fell by 8.2% y/y,
versus a fall of 7.8% y/y prior, as shown in Chart 1. On a month-on-month (m/m) seasonally adjusted (sa)
basis, however, prices have stopped falling since March. Since then, prices have risen a bit, and in July both
were basically flat, as we show in Chart 2.

Important disclosures can be found in the Disclosures Appendix.

Ref: GR_20Jul09
 On the Ground | 11 August 2009

Inflationary expectations have risen, though. While the recent PBoC report toed the official line, we know that
the central bank is much more concerned than other government agencies about inflation (see OTG,
5 August 2009, ‘Monetary policy update’). We forecast that CPI will return to positive y/y growth around
November. This will likely be one of the triggers of a shift in the overall monetary policy stance. This shift will
likely involve hikes in the required reserve ratio (RRR), which we expect in Q4, to be followed by interest rate
hikes in H1-2010, and even possibly loan quotas. The RRR hike is significant, as the PBoC needs the State
Council to sign off before it can go ahead. However, today’s data does not bring that day closer.

Chart 1: Prices falling year-on-year…. Chart 2: . . .but stable m/m

12 3

9 2
6
1
3
0
0
-1
-3

-6 -2

-9 -3
Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-01

Jan-03

Jan-05

Jan-07

Jan-09
CPI, y/y % PPI, y/y % CPI, m/m sa % PPI, m/m sa %

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

All eyes on infrastructure projects and real estate

Fixed asset investment (FAI) continued to grow in July – we calculate a 29.7% y/y increase, as shown in
Chart 3. (In real terms, FAI rose even faster, by around 34% y/y.) Given the large volume of planned
investment, the accommodative policy stance, and the gradual recovery in private investment, we expect FAI
to remain strong. However, it appears as though the momentum has ebbed here, too. The nominal growth
rate of 29.7% y/y in July was a deceleration from the monthly average of 35% y/y in Q2. (This data, though, is
problematic, so we do not have huge confidence in it alone.) However, corroboration is provided by project
data. There were only 29,600 new project starts in July, compared to a monthly average of 41,060 in
Q2-2009. In fact, July saw the first negative month-on-month growth in new project starts since October 2008
(adjusting for Chinese New Year). This is further evidence that the stimulus package was heavily frontloaded,
meaning that investment growth may well plateau around these levels for a while.

Ref: GR_20Jul09

2
 On the Ground | 11 August 2009

Chart 3: Continuous strong FAI growth Chart 4: Are house prices too high now?

70 50 150

60
40 100
50
30 50
40

30 20 0

20 10 -50
10
0 -100
0

Jan-06

Jan-07

Jan-08

Jan-09
Jan-97

Jan-99

Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Housing investment, y/y %, 3mma

FAI growth, y/y %, 3mma
Housing sales, y/y %, 3mma (RHS)

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

This view is supported by the still-muted recovery in real estate investment. Real estate FAI only rose by
12.7% y/y in July, lower than June’s 14.6% growth (as shown in Chart 4), and still well below the 30% rates
we witnessed over 2006-07. Housing sales, measured by floor space sold, grew by 69.6% y/y, up from June’s
54%. However, sales volume fell by 20.3% m/m in July, following growth of 35.3% in June. In Shanghai,
many developers seem to be keen to hold on to apartments, waiting for further price rises before they release
them. They are also probably not keen to start a massive wave of new projects until they feel surer about the
medium-term future. New home prices rose by 1.1% m/m in July, according to official numbers, up 0.3ppt
from June (though these numbers look very low to us – in Shanghai many apartment blocks are 30%+ up
since January). There is some worry, both in the market and from officials, that the rises in home prices may
have started to weigh on demand, especially among first-time buyers.

Industrial production growth flattened despite a stronger PMI

Industrial value added (IVA) grew by 10.8% y/y in July, following a 10.7% rise in June (see Chart 5). While
strong, this was below market consensus and suggests some deceleration in production momentum. The
recovery in electricity production also weakened a bit, with growth slowing to 4.8% y/y from 5.6% y/y in June
(though electricity production was up 18% m/m). Demand from stimulus-related infrastructure projects and
the end of the de-stocking cycle have been behind the improvements seen here since Q2-2009. According to
the Purchasing Managers’ Index (PMI), manufacturing new orders are still growing month-on-month, as
shown in Chart 6. Inventories of finished goods fell by 2.2% y/y in July, suggesting that firms will be
increasingly willing to build inventories of finished goods in the next few months (see OTG, 3 August 2009,
‘Through the inventory cycle’).

Ref: GR_20Jul09

3
 On the Ground | 11 August 2009

Chart 5: Industrial production flattens Chart 6: PMI suggests an end of destocking

25 15 20
10 15
20 5 10
5
0
15 0
-5 -5
-10 -10
10
-15 -15
-20 -20
5
-25
-25
-30
0 -30

Jul-07

Jul-08

Jul-09
Jan-07

Jan-08

Jan-09
Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09
New orders
IVA, y/y % Purchases
PMI production, y/y % Finished-goods inventories

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

Retail sales stabilise on recovering confidence

Retail sales rose by 15.2% y/y in July. In real terms, as shown in Chart 7, growth seems to have plateaued at
around 17% y/y. According to eziData, consumer confidence continued to recover in June, as we show in
Chart 8. Car sales continue to motor along.

Chart 7: Sales stablise Chart 8: Recovering consumer confidence

24 105
103
101
18 99
97
12 95
93
91
6 89
87
85
0
Oct-07

Oct-08
Apr-07

Apr-08

Apr-09
Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

eziData China Consumer Confidence Index

Nominal retail sales, y/y %, 3mma (CCCI)
Baseline survey, April 2007 = 100
Real retail sales, y/y %, 3mma

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

Far fewer new loans to the corporate sector

CNY 355.9bn (USD 52bn) of new loans were extended in July, a considerable slowdown compared with
CNY 1.53trn (USD 225bn) in June, as we show in Chart 9. Digging into these numbers shows an even
sharper slowdown in lending to the corporate sector. CNY 236.5bn of the net increase went to households,
who were busy buying homes with mortgages, while only CNY 119bn went to corporates (CNY 198bn worth
of bills were repaid in July, as were CNY 58bn in short-term loans, while CNY 350.9bn worth of medium- and

Ref: GR_20Jul09

4
 On the Ground | 11 August 2009

long-term loans were extended). Net extension of credit to the corporate sector in July was thus the smallest
since November 2007, according to our numbers. After the blowout in June (when CNY 1.228trn of net loans
were extended to corporates), a sharp slowdown was always going to happen, but this may still unnerve the
market and is another signal that the momentum has dissipated. There is still no shortage of money supply
growth, though – broad money supply (M2) rose by 28.42% y/y, as we show in Chart 10.

Chart 9: Exploding new loan extension Chart 10: Explosive money supply growth

2,000 40

1,500
30
1,000

20
500

0 10

-500
0
Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-01

Jan-03

Jan-05

Jan-07

Jan-09
Medium- and long-term, CNY bn
Short-term and bill finance, CNY bn M2, y/y % CNY loan, y/y %

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

Based on our understanding, the PBoC will be happy to maintain new loan growth at CNY 400-500bn (USD
59-73bn) per month for the remainder of the year – CNY 2.5trn (USD 366bn) for all of H2-2009, or CNY 10trn
(USD 1.5trn) for the whole of 2009. The July data will calm some nerves. Anecdotal news suggests that
demand for loans is still strong, so all eyes will be on the August numbers to see if July was just post-June
exhaustion or if it really did mark a change.

Imports up
Exports fell by 23% y/y in July, and imports fell by 14.99% y/y – both a little weaker than June in y/y terms.
We show the three-month moving averages in Chart 11. In month-on-month terms, some positive momentum
continues – exports are rising 5% m/m in nominal terms on a 3mma basis, while imports are rising 7% on the
same basis. We do not have volume data for July yet, but looking at June, we note an important shift on the
import side. In real (volume) terms, imports grew by 3.7% y/y in June, while exports continued to fall, but the
decline slowed to 14% y/y. (Chart 12 shows these numbers on a 3mma basis, which disguises the recent
strength a bit but also removes some of the volatility.) We suspect that this trend continued in July – another
sign that domestic demand has recovered – but that there was no further acceleration in July. The trade
surplus of USD 10.6bn in July was bigger than expected, but not by much.

Ref: GR_20Jul09

5
 On the Ground | 11 August 2009

Chart 11: Imports are recovering (nominal) Chart 12: Imports are recovering (real)

40 40
30 30
20 20
10 10
0 0
-10 -10
-20 -20
-30 -30
-40 -40
Jan-06

Jan-07

Jan-08

Jan-09

Jan-06

Jan-07

Jan-08

Jan-09
Export, y/y %, 3mma Export, y/y %, 3mma
Import, y/y %, 3mma Import, y/y %, 3mma

Sources: CEIC, SCB Global Research Sources: CEIC, SCB Global Research

Less arbitrage buying of commodities

China has reduced speculative imports of some commodities, mainly copper and aluminium. In some other
commodities, such as crude oil and iron ore, imports have increased alongside a recovery in demand and
anticipation of further price hikes. Here, we discuss copper and iron ore.

As Chart 13 shows, China’s imports of copper and copper products dropped from a record high in June to
406.6 thousand tonnes (kt) in July. We estimate that of the July imports, around 325kt was refined copper,
down 14% m/m. This is the first time that imports have fallen m/m in seven months, although the numbers are
still much higher than a year ago. The difference between London and Shanghai prices has meant that
imports have been loss-making since early June. With few arbitrage opportunities in July, we expect China’s
copper imports to fall further in August.

China’s iron ore imports in July continued to reflect a mixture of real demand and speculation. They hit a new
record high of 58.08mn tonnes, up 47% y/y and 5% m/m, as Chart 14 shows. Imports in the first seven
months of 2009 rose by 32% y/y to 355.4mn tonnes. While record-high crude steel production has
encouraged these imports, trading houses continue to import because they anticipate even higher steel
production and higher prices in the coming months. Meanwhile, these traders continue to have access to
easy credit from local banks. But we also note that some traders have already started to take a more cautious
view of imports because of higher ore prices and some weakness in domestic steel prices. According to
‘Steel Index’, an industry publication, 62% iron-content iron ore fines delivered to China hit USD 104.1 per dry
tonne yesterday, the highest level since the index began on 21 November 2008. An additional risk is that
banks may tighten credit lines, but so far we have not heard of any instances of this.

Ref: GR_20Jul09

6
 On the Ground | 11 August 2009

Chart 13: Copper imports Chart 14: Iron ore imports

Thousand tonnes USD/tonne

500 70

60
400
50
300 40

200 30

20
100
10

0 0
Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09

Jan-07

Jul-07

Jan-08

Jul-08

Jan-09

Jul-09
Copper and copper products
2007-2008 monthly average Iron ore 2007-2008 monthly average

Sources: Chinese customs, SCB Global Research Sources: Chinese customs, SCB Global Research

Ref: GR_20Jul09

7
 On the Ground | 11 August 2009

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 On the Ground | 11 August 2009

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Data available as of 07:00 GMT 11 August 2009. This document is released at 08:00 GMT 11 August 2009.
Document approved by: Nicholas Kwan, Regional Head of Research, Asia

Ref: GR_20Jul09