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China
Growth Still Fast but Should Not Trigger More Tightening January 25, 2007 By Denise Yam | Hong Kong Economy expands 10.7% YoY in 2006: GDP growth beat expectations in 2006, partly attributable to the upward revisions to figures in the first three quarters (1Q from 10.3% to 10.4%, 2Q from 11.3% to 11.5%, 3Q from 10.4% to 10.6%). Growth actually decelerated for the second straight quarter in 4Q06 to 10.4% (+10.6% in 3Q), led by a slowdown in fixed asset investment that more than offset continued strength in exports and domestic consumption. Nominal GDP reached Rmb20.94 trillion for the year, up 13.9% YoY. We estimate that Fixed investment slowed: The slowdown in (urban) fixed asset investment growth to 18.6% in 4Q from 24.2% YoY in 3Q was the main driver behind the growth deceleration. Including capex in rural areas, total fixed investment in the economy also cooled, up 24% for the year, down from 27.3% in 1-3Q, and totaling Rmb11 trillion. Urban FAI in December alone rose just 13.8% YoY, far below expectations, and the slowest ever recorded since the introduction of the new dataset in 2004. This probably helped explain the softer growth in industrial production in December (+14.7%) and 4Q (+14.8%), although for the full year, industrial output growth picked up to 16.6%, from 16.4% in 2005. Consumer demand robust and resilient: Macro tightening over the past few years and the resulting gradual slowdown has not affected consumption, as policymakers have intended. Support given to the household sector, such as raising minimum wages in cities and subsidies and support to rural households, has given a boost to consumer demand. Retail sales growth accelerated to 14.6% YoY in December, and averaged 13.7% for the year, picking up from 12.9% in 2005. Although we remain wary that China’s ‘retail sales’ data incorporate part of the fixed investment story, such as the sales of construction and renovation materials and furniture, consumers are indeed spending more. There has been some genuine pick-up in the sales of non-investment-related consumer goods, such as cosmetics, jewellery and autos. CPI inflation higher than expected, but caused mainly by food: The sharp pick-up in CPI inflation to 2.8% YoY in December triggered concerns of more monetary tightening through interest rate hikes. However, we deduce from the full-year statistics that food inflation, especially in grains, picked up significantly in December. The 2006 average of 2.3% implied that food prices jumped at least 5% YoY in December, compared with 3.7% in November and 2% in the first 11 months of last year. This alone would have accounted for most of the uptick in inflation in the month. Overall consumer inflation averaged 1.5% in 2006, easing from 1.8% in 2005. Producer (+3.1% in December versus +2.8% in November) and raw materials (+5.0% versus +4.8%) prices showed stable gains. We do not think that the latest price indices data should trigger a rate hike in the immediate term. Reiterating concerns: While describing 2006 economic performance as satisfactory, with “faster growth, higher efficiency and lower inflation”, the National Bureau of Statistics reiterated concerns about the outstanding problems in the economy, which include: (1) a weak agricultural sector, (2) the imbalance between investment and consumption, (3) the external imbalance, (4) excess liquidity in the banking system, and (5) energy consumption and pollution. Liquidity management still dominates policy stance in short term: We agree that macro controls need to be maintained to prevent overheating again. With sustained availability of low-cost capital from the balance of payments surplus, We believe that it is vital to follow the trends in the interbank market, following the formal introduction of the SHIBOR and a more market-driven reference curve for the onshore market. In our view, the PBoC is paying increasing attention to enhancing money market mechanisms so as to effectively gauge the demand and supply of funds. We continue to expect that, in the immediate term, liquidity management through reserve requirements and bond issues should dominate the policy space. Movements in interbank rates have probably become more relevant as an indicator of policy stance than the traditional deposit/lending rates. Nevertheless, higher deposit and lending interest rates remain an ingredient of our medium-term outlook for We forecast 9.3% real GDP growth in 2007: We expect The continued shift in
UK
Inflation and Monetary Policy in the UK January 25, 2007 By David Miles | London The Monetary Policy Committee (MPC) at the Bank of England was split 5-4 on the vote over a rate rise at its January meeting. Inflation had clearly been somewhat higher than the committee had expected, but with no clear signs of wage pressures having picked up it was not obvious that its previous central forecast that consumer price (CPI) inflation would move back to target later in the year should be significantly altered. This was why the decision on the rate rise was such a close one. Our central forecast is that at unchanged rates annual CPI inflation will hover fractionally above 3% for the next couple of months but drop back quite rapidly towards the 2% target by mid-summer. Retail price inflation (RPI) may rise a little further to around 4.6% in the very near term. But as energy and fuel price rises — stemming from significant oil and gas price increases in the first part of 2006 — fall out of the year-on-year comparisons, inflation on all measures is likely to fall back sharply by autumn. The drop in the annual rate of inflation is likely to be more rapid for CPI inflation than for headline RPI inflation since the RPI includes the impact of the rate rises that will have increased mortgage payments for many home owners. With a central forecast for annual CPI inflation in January at marginally above 3.0%, it becomes a knife-edge issue as to whether the figure would be rounded to 3.1% or down to 3%. Our assessment is that it is close to a 50/50 chance that the 3% limit is breached and a letter written by the Governor to the Chancellor explaining why inflation had moved more than 1% from the 2% target level. But with inflation on our central forecast likely to then drop back to target — which we suspect is also the MPC’s view — our assessment of the single most likely outcome on monetary policy is that no more rate rises will be warranted. The key risk — well flagged in the MPC minutes — is that wage settlements pick up and inflation becomes more entrenched than our central forecast. In that case, a period of rates moving above 5.25% (which we judge to be close to a neutral level) would be expected. But there are also risks that growth turns out rather significantly below trend and that inflation pressures subside even more sharply than our central forecast. So, the risks either side of our central forecast for rates now looks more symmetric than before the January rate rise. We have updated our assessment of the probability distribution of rates for June of this year in the light of the January rate rise and how that decision was reached. Our assessments of the single most likely outcome (the mode), the probability-weighted outcome (the mean) and the outcome with an equal chance that the rate is above or below it (the median) are all now close to the current rate of 5.25%. This is a reflection of a high degree of symmetry of risks around our central forecast of where rates might go over the next six months.
Europe
Europe and Macro Risks January 25, 2007 By Eric Chaney | London Three main themes emerged from Morgan Stanley’s annual Macrovision seminar, held in In short, my conclusions are: 1. A liquidity crisis could seriously hit markets where the presumption of a housing price bubble is the strongest, and would also be a serious issue for the global financial platform that 2. A drop in commodity prices would benefit European economies in general, but probably less than the 3. A rising tide of protectionism would have the most serious consequences for the EU, which is both the largest exporter in the world and the least protected. What if a financial accident happened in Although most investors and market participants would concede that the world economy is awash with liquidity, it is harder to get a consensus view about what this exactly means. As Stephen Roach concluded, “macro conclusions on liquidity are likely to be more subjective than objective” (Foolproof, January 22, 2007). However, we know what a liquidity crisis is: a period during which some economic agents which, in normal times, have access to capital markets, either directly (companies, sovereign states) or indirectly (by the intermediation of banks) see this access more or less restricted. I see two very different types of circumstances that could initiate a liquidity squeeze. First, central banks could tighten monetary policy excessively, either because inflation gets out of control, or as a result of an overly optimistic judgment on the health of the real economy. Although policy mistakes should never be excluded, my subjective view is that, as far as the ECB and other European central banks are concerned, this risk is extremely low. The other case is a financial accident, itself the result of excessive investment in risky assets, because of abnormally compressed risk premia. Although the probability of such financial accident is arguably low, it is certainly more likely than a central bank ‘overkilling’. For markets as well as for policy makers, the real surprise would be a large-scale financial accident originating in Europe, not in the If commodity prices fell, not everybody would smile Being the second-largest net importer of commodities in the world, the EU would benefit from a large drop in commodity prices, without any doubt. Companies’ profits and consumers’ purchasing power would rise and this would result into stronger consumer spending and corporate investment. There are nevertheless some caveats. First, both nominal and real long-term interest rates would probably rise. A mix of stronger demand growth and lower inflation would probably slow the monetary normalisation process the ECB is embarking upon, but it would not reverse it, because of the still low level of real rates. Also, capital inflows from oil and other commodity exporters ( Protectionism: A serious risk for Protectionism is a multiple-headed monster. Beyond well-documented traditional trade protectionism, such as tariffs and duties, it may take other forms, such as government-sponsored exchange rate policies, non-tariff barriers and ‘capital protectionism’ (i.e., restrictions on foreign ownership of local companies). Among all these risks, the former look the less likely while the latter is gaining popularity across the globe, including within In conclusion, although sharing the Macrovision consensus view, I believe that there is some complacency in the assessment of macro risks in
Korea
Further Slowdown Ahead January 25, 2007 By Sharon Lam | Hong Kong Today’s GDP data confirm that the Korean economy slowed, but not by as much as the headline number would suggest. Headline real GDP growth eased to the lowest level since 2Q05 at +4% YoY in 4Q06, from +4.8% in 3Q06. This also fell short of market expectations, which centered on 4.2%. However, taking into account the -0.2% margin for statistical discrepancy, the headline number was pretty much in line with expectations. Almost all categories registered slower growth, most visibly capex. Construction spending was the only element that continued to reaccelerate. Nevertheless, a slowdown trend cannot be denied as sequential growth contracted to +0.8% QoQ (seasonally adjusted) in 4Q from +1.1% in 3Q, which ticked up from +0.8% in 2Q. This dashed the hopes of investors who were starting to believe that the Korean economy might be recovering after the 3Q rebound. As we predicted, the 3Q rebound has proven to be only temporary. Full year 2006 GDP growth concluded at 5%, slightly shy of our forecast of 5.1%. We keep our 2007 forecast unchanged at 4.3%. A brief glance at the growth breakdown: Private consumption (in line): Consumption slowed along with overall growth as expected, but its contribution to GDP growth remained steady at around 40% — the same as in previous quarters since consumption began to recover after the credit card bubble. On a YoY basis, private consumption growth eased to +3.6% in 4Q from +4% in 3Q. We believe that government action will be required to revive consumption; otherwise, we should expect more deceleration in the coming months, though we continue to stress that this downturn will be mild, given the absence of over-consumption. Government consumption (in line): Government spending picked up further in 4Q, growing at its strongest level since 2002 at +6.5% YoY, compared with +5.8% in 3Q. This increase had been expected as more budget spending was pushed into 2H06 to help a slowing economy. Nevertheless, the significance of government spending is still too small to make a difference to the economy — the government continues to stick to fiscal discipline in order to maintain a strong sovereign rating. We do not expect any considerable increase in government spending even during this election year, but we believe that the government could use administrative policy to help the economy. Facility investment (disappointment): We had predicted capex growth to cool amid expectations of weakening exports and corporate profitability due to excessive currency appreciation. Meanwhile, we also thought that the capex recovery cycle, which started in late 2005, should end after one year since Construction investment (upside surprise): The construction sector has continued to bottom out since 2Q06 and the jump in 4Q was stronger than expected, climbing +2.9% YoY versus around -0.6% in 3Q and -3.9% in 2Q. The replacement of infrastructure destroyed by serious flooding during the summer may partly explain the increase in construction spending. We expect construction activities will keep improving this year as the government has pledged to increase home supply. Meanwhile, output from real estate-related activities also jumped to +4.9% YoY in 4Q, the strongest growth since 2002, but one may argue that this could be a result of the rush to make transactions before the government’s housing tax measures come into effect in 2007. Inventory decline (more than expected): The decline in inventory took away 0.9% of GDP growth in 4Q, as the clearing of backlogged orders resulting from the labor strikes in 3Q dipped into inventory. If new production was used instead of inventory, then 4Q’s GDP growth could have actually been higher. Nonetheless, we also interpret the use of inventory as an indication that manufacturers are anticipating lower demand ahead, and are thus reluctant to increase production, preferring to tap into inventory. Exports (in line): Export of goods in volume terms was weaker in 4Q, slowing to +11% from +13.4% in 3Q. If not for the delayed shipments that pushed into 4Q after the labor strikes in 3Q, export growth could have been weaker in the last quarter. We expect to see greater loss in export momentum in 1H07 as demand from both the Bottom line We view these data as confirmation that the economy’s 3Q rebound has not continued as some had hoped, but rather it has slowed on weaker exports and capex. We expect more export-led deceleration in 1H07, with a bottom likely in 2Q07. On the other hand, we believe that construction activities will keep picking up moderately, which could help consumption via the creation of jobs. Steady housing prices are also essential to help revive consumer sentiment in 2007, in our view. We believe that house prices are unlikely to crash in 2007 as housing supply should jump more significantly starting in 2008. Meanwhile, we believe that the central bank will keep the interest rate untouched in 1H07 in order to create a balance between a slowing economy and rising property prices. We still see chances of more rate hikes should the economy start to recover in 2H07 as we predict, because the current interest rate, which is barely at a neutral level, is still too low to combat any property market bubble. While we do not see any significant risk to the economy (no noticeable asset bubble, no credit bubble and no consumption bubble), we also think that the Korean economy is lacking growth catalysts due to structural challenges. As a result, although we believe that momentum will pick up in 2H07, we do not expect to see any sharp rebound. However, upside risks still exist if the government relaxes housing policy or encourages more consumption.
Turkey
Barrel by Barrel January 25, 2007 By Serhan Cevik | London The fall in oil prices is good news for Soaring commodity prices are the most important reason for the widening current account deficit. The average price Turkey paid for imported crude oil surged from US$16.5 a barrel in the 1990s to US$26.9 in 2003 and then to a peak of US$64 last year. As a result, energy imports — crude oil, oil products, natural gas, liquefied petroleum gas and coal — increased from US$11.6 billion in 2003 to US$21.2 billion in 2005 and US$28.2 billion last year. Put differently, the country’s energy imports snowballed from 4.8% of GDP in 2003 to 5.9% in 2005 and 7.3% last year, accounting for 60% of the deterioration in the current account deficit from 4.4% of GDP in 2003 to 8.5% in 2006. This is why we have always called for caution in analyzing nominal figures and removing distortions created by surging commodity prices. For example, had the price of oil remained at its 2003 level, Turkey’s net energy imports would have been US$7.3 billion (or 2.1% of GDP) lower in 2005 and US$13.1 billion (or 3.4% of GDP) lower in 2006. Accordingly, the current account deficit would have narrowed from 5.8% of GDP in 2004 to 5.1% last year (or 4.8% if we also take into account the rise in gold prices), instead of widening to 8.5% of GDP. The fall in oil prices should lower the current account deficit and accelerate disinflation. According to our calculations, a US$10 drop in the price of crude oil lowers |