The Chinese economic slowing has resumed


Despite January’s negative inflation rate, we still look for mildly positive inflation for 2021. In this note, we examine a few factors that are likely to impact China’s inflation throughout the year, including CPI’s base effect and revised weights, the pork cycle, consumer confidence, credit growth and the external environment.

In detail, the base effects expected to tame consumer inflation in Q1 but should be neutral over the full year. We foresee a gradual decline in pork prices driven by large-scale hog restocking. In our view, while domestic inflation will be supported by recovering consumer sentiment, slowing credit growth in the public and real estate sectors will keep the inflationary pressure in check. Although we are likely to see some imported inflation this year, such impact is expected to be relatively insignificant. In this sense,we do not see any broad-based tightening measures by the PBoC this year.

China kicked off 2021 with a deflationary January (CPI:-0.3% YoY), due to a high base from last year. Back in January 2020, consumer prices were boosted by the usually strong demand ahead of the lunar new year holiday and yet affected by the COVID pandemic.The base effect is estimated to be-1.2pptfor this January and-1.4ppt for February (Fig1).

Apart from the inflation rate, the NBS also published China’s new CPI weights which are adjusted every five years. As household income grew further, the food weight in China’s CPI basket was lowered as expected, by1.2ppt. Meanwhile, other significant changes include less weight for clothing (-1.7ppt) and heavier weights for residence (+2.1ppt) and healthcare (+0.9ppt).

Despite those changes, little impact on China’s inflation rate is expected from the new CPI weights (NBS:±0.03ppt on average). Instead,we think key drivers for inflation this year are the pork cycle, consumer confidence, credit growth and the external environment.

In our view, the current pork cycle supports moderating consumer inflation in 2021. While pork prices saw MoM increases both in December and January, we doubt that trend will last. Apart from traditionally strong pork demand leading up to the LNY holiday, cold weather in most areas in China also helped push up the prices.

That said, fundamentals are in favor of falling pork prices further out. Note that both hog and sow stocks have risen to a six-year high after months of restocking, and the current hog-corn price ratio of over 11x is indicating a very profitable industry, foreshadowing further increases in future supply(Fig2).

On the demand front, we have seen a recovery in consumer sentiment, likely supported by the recent rise in property and equity prices (Fig3). In addition, pent-up household demand could be unleashed as China’s outlook stabilizes further, driving a catch-up rebound in consumer demand. Note that China’s household saving deposits have been rising significantly faster than household income during the past two years(Fig 4). Such recoveries, in our view, will add to inflationary pressure, especially for non-food prices.

A slowdown in credit growth will keep the inflationary pressure in check. Note that the PBoC has pledged to curb the rise in China’s debt ratio, amid efforts to balance support of economic growth with curbing financial risks. As of year-end 2020, the total debt-to-GDP ratio jumped to 270.1%, up 23.6ppt from a year earlier (Fig5).

In fact, measures have already been taken by Beijing to curb credit growth, including: 1) no quota yet set for 2021 local government bond issuance (vs.2020 quota set in Dec 2019), 2)newly introduced caps on bank lending to the real estate sector (40% of outstanding loans for the real estate sector and 30% for home mortgage, effective on 1 Jan), and 3) eight more property developers, in addition to the previous 12, were brought under the regulation of “three red lines” that force overly indebted developers to deleverage.

Despite January’s solid increase in bank loans, at an historical high of RMB3.58trn, the YoY growth moderated. Moreover, government financing slowed notably in January, reporting its smallest increase (RMB244b) since last February, hinting at slowing investment led by the public sector, as stabilizing growth is now less of a policy priority for Beijing’s policymakers. As a result, YoY growth in total social financing (TSF), which measures financing by the non-financial sector on a broad basis, was tamed to a six-month low (Fig6).

David Llewellyn-Smith
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