June 29, 2010
Goldman Sachs Global Economics, Commodities and Strategy Research at https://360.gs.com
Michael Buchanan firstname.lastname@example.org +852 2978 1941
After extensive client discussions, we still think the sequential slowdown in China will be greater than the market has been expecting
After three weeks of meetings in Japan, continental Europe, UK and then this week inHong Kong, we continue to believe that the market is expecting less of a sequential slowdown in Chinese growth than we think may occur in the near term. This follows our note on June 10, where we highlight that there are growing downside risks to our forecasts, and also the webcast we did on June 21 after China announced the changes in its currency regime. However, we remain very positive on theoverall China outlook beyond the near term. In particular, we still completely disagree with the vocal but small minority that see China as a “credit driven investment bubble” – China has run aggressively counter-cyclical policy before the global credit crisis and so had room for the substantial easing (700bps in FCI terms) without seeing excess credit growth rise to the levels of other majorcountries. The temporary policy-driven slowdown could be offset subsequently by recalibration of policy (hence the importance of our “risk based approach to tightening”, where the bulk of the tightening is delivered by measures that are easy to adjust in response to changes in the growth outlook (i.e. mainly loan guidance). While investors in Hong Kong have in general been more focused on thetightening than those outside the region, even these investors do not seem to have been expecting much of a near-term sequential slowdown. The only type of investors that seemed to have a similar view on the extent of the downturn were a small number of dedicated commodity funds and some investors in the domestic market, although the issue is becoming ever more the centre of attention.
The market reaction to the change in the CNY regime announced on June 19 may have been misinterpreted by the market and partly explain the views above. Some investors felt that China would not have announced the change in exchange rate policy if growth were slowing to any significant degree. However, we continue to argue that the primary motivation for the currency move is political ratherthan economic – while that may appear obvious given the real risk of protectionist measures in the US, it also implies that the amount of tightening delivered by nominal appreciation will be modest and that it does not require strong sequential growth as a
Goldman Sachs Global Economics, Commodities and Strategy Research
precondition. Rather, it seems that China moved assoon as the extreme uncertainty about Europe faded a touch. If our pre-existing CNY forecasts turn out to be right (and we continue to think they are appropriate) – i.e. a 5% annualized appreciation against the USD, implying a touch under 3% by end-year – this would deliver only a modest 30bps of tightening on our FCI (assuming no changes in any other currencies). If our other global FXforecasts are right, then this would imply an overall 4.5% trade-weighted appreciation, delivering around 50bps of tightening. This is modest compared to the more than 300bps of tightening China has delivered since last year (and an original forecast for a total of 400bps of tightening by end-2010), and so can be accommodated within the overall stance of policy without significant difficulty. So while itwas the case that China would not appreciate its currency at all when there was significant unemployment in the coastal areas last year, we do not think that the move this month implies that there is no risk of a greater sequential slowdown now.
As we said in the piece on June 10, much of the sequential slowdown is probably already happening even though it hasn’t shown up broadly...