Looks Good So Far, Looks Ominous Ahead: June Tankan Preview
June 21, 2010
By Takehiro Sato | Tokyo
The Economy Has Lately Been Encouraging
The June Tankan will look encouraging, especially in the context of mounting uncertainty over the global economic outlook. We expect the headline to improve for the fifth straight quarter, and capex plans to be revised up in line with what our comparatively upbeat domestic economic forecast would imply. Yet remember that the Tankan is simply a reflection of the current corporate mindset, and tends to be backward-looking.
Favorable recent economic data and political unrest within the DPJ have delayed the timing of the additional easing that we expect from the BoJ, but we still think that political pressure could lead to inflation targeting or an increase in JGB purchasing operations. But the potential for political uncertainty to continue after the upcoming Upper House elections means that monetary easing will probably not return to the policy agenda until early autumn or later.
Business Conditions DI Forecast: Further Headline Improvement Ahead
Thanks to exports to Asia, which are maintaining a hot pace near the past peak in volume terms, we expect another sizeable improvement in the headline DI (business conditions for large manufacturers), from -14 in March to -4 in June. Exports remain solid even though the effective yen rate is rising. The outlook DI, despite a slowing improvement, is on course to move higher again in the September Tankan.
We also anticipate further gains in the DI for large non-manufacturers, as personal consumption has been reacting to the government's spending stimulus, moving from -14 last time to -8.
We think that the DI for SME (small/medium-size enterprises) will continue to show a contrast between manufacturers and non-manufacturers, but the Economy Watchers Survey (a leading indicator) showed sharp improvement over five straight months through April. This dropped back slightly in May, but should not affect the trend of improvement for the Tankan DI.
Look for the input and output price DIs to highlight a slowing pace of margin deterioration overall, despite persistent downward pressure on final goods prices, as input prices are weakened by the recent correction in commodity and energy prices and the gains for the yen.
In terms of direction, DIs relating to the output gap - production capacity, employment, etc. - are likely to show that the sense of surplus is peaking out, but in terms of level we expect strong signs of capacity surpluses to persist. Though capex has begun picking up as of October-December, absolute levels of utilization rates remain low in historical terms, at 70-75%, and neither has there been much progress with decommissioning or scrapping production plants. We expect these DIs to point to risk of prolonged deflation.
Our Forecast for F3/11 Business Plan Revisions
1) Expect sales and profit plans to move up slightly
It was difficult to get an accurate grasp of the overall picture from the March Tankan alone, as most institutions had not formalized recurring profit plans by the survey date, and disclosure has become more restricted. This time there are no such problems, as results data will have been reflected, and in this respect the June Tankan business plans are significant.
The pattern of revisions in the June survey of past years is for modest upward revisions for sales during booms and modest downward revisions during downturns (F3/10 was an exception). There is no similarly clear pattern for profit plans, though it appears that rates of upward revision taper off during recessionary periods (exceptions were F3/09 and F3/10). In light of these patterns, we look for targets to move up by about 1-2% for sales and 3-5% for profits. The profit plans of large enterprises will probably call for year-on-year growth of about 25%, which looks conservative when compared to our top-down forecast (parent-basis recurring profits to increase 50%Y), but we note that the straightforward comparison is difficult because of disparities between consolidated and parent forecasts.
Exporters also seem better able to cope with a strong yen. We gauge the breakeven rate for exports (all manufacturers) for April-June as about JPY90/US$, near the spot rate, mainly due to capacity utilization recovery and lower input costs.
2) Expect upward revisions in F3/11 capex plans to emulate the past pattern
Capex plans of large enterprises/all industries were more or less flat year on year (-0.4%) in the March Tankan. However, this figure is not very reliable as companies had yet to draw up official plans at the time of the last survey. Thus, the June Tankan will be the first opportunity to confirm companies' official stance. With the exception of F3/94, F3/03 and F3/10, the pattern of adjustments in the past points to a visible tendency for across-the-board upward revisions. Upward revisions were particularly large, on the order of 5%-plus, from F3/05 as the global economy overheated. This year, the January-March GDP data have already confirmed that capex is recovering, and we anticipate upward revisions to full-year targets more or less in keeping with the usual pattern. Even so, although companies are increasing capex on a consolidated basis - i.e., at overseas production subsidiaries - they are generally holding back from domestic capex. This too has a bearing on the issue of differences between consolidated and parent stances, and we think it is worth taking note that stances on capex have become harder to read. Ultimately, although domestic capex is already below depreciation levels, we find it hard to picture a scenario of genuine recovery. We only expect upward revisions to capex plans by large enterprises/all industries to follow the usual adjustment pattern, coming out at +3.9%Y (+2.0pp rate of revision), including +5.1% (+1.9pp revision) for manufacturers and +3.5% (+2.0pp) for non-manufacturers.
We see backing for our view that capex recovery is likely to be weaker than in earlier recovery phases in the aforementioned consolidated-parent differences, as well as the subdued comeback in line utilization rates. In April-June, line utilization rates have finally regained the lower 70% level, still only in line with past recessions, and look weak by comparison with production recovery. We attribute this to near-zero progress with cutting production capacity, unlike in the aftermath of the IT bubble collapse.
Policy Implications: Expect Loose Monetary Policy to Continue, and Intensify, Despite Ongoing Cyclical Recovery
From our analysis of the output gap, we think it will be about 2013 at the earliest that underlying prices excluding foods/energy and systemic factors turn positive. There is even a possibility that factors like demographics are causing a downward shift in the medium-term inflation expectations of households and businesses. It is possible that after some 15 years of uninterrupted deflation since the mid-1990s, households and companies are now taking deflation as a given in their behavior patterns. It could also be argued that deflation is not wholly inappropriate in an aging society with a high proportion of pensioners.
If households and businesses think that prices will not rise in the medium-longer term, they are likely to put off consumption and investment, and the resulting further slump in demand is likely to impede improvement in the output gap, with the end result that deflation worsens further. This is something the BoJ has already identified as a risk factor for lower-than-expected prices in its Outlook Report. At the same time, up to now the BoJ has been reluctant to undertake further monetary easing on the grounds that medium-longer-term inflation expectations are stable. Equally, however, we have been pointing out that the grounds for this stance may have been undermined.
It is against this backdrop that we have consistently argued that additional easing will be needed. However, the fact remains that the BoJ itself is still very reluctant to do this, and we do not see it happening unless, for example, spreading concern about European sovereign debt pushed the yen ever-higher and the stock market to crashing point. Politically, too, the situation of the DPJ, which has kept up the pressure on the BoJ, lends weight to the BoJ's position in maintaining its current stance. The fall in popularity of the earlier Hatoyama government leaves less latitude for the government/ruling party to play a part in monetary policy. DPJ moves to stimulate the debate on ending deflation appear to have died down, and it seems less likely than before that the manifesto for the upcoming Upper House election will call for setting an inflation target. Forging the new lending system to support growth fields that the BoJ has been working on may also be seen as an opportunity to improve relations between the government and the BoJ.
Taking all of these considerations into account, earlier this month we push back our forecast for additional monetary easing to October-December, two quarters later than we had been anticipating.
The Lehman events in 2008 administered a short, sharp shock to the system, whereas the current sovereign debt problems, due to the fiscal deficits that have soared as a result of the financial crisis, may turn out to be a longer-lasting problem (depending on the viewpoint, more serious even) as they have damaged the robustness of the public sector which has supported the financial system. From now until year-end, we await a series of events such as sovereign credit ratings of southern European countries, approval or rejection of government budgets that reflect austerity packages imposed by the IMF, and the quarterly review of whether the conditionalities for IMF aid are being met. The market is likely to swing in reaction to the possibility of debt restructuring or otherwise as implied by each event. If escalation of these problems leads to yen buying by a process of elimination as a safe-haven currency, and this undermines stock prices, a renewed burden could fall on monetary policy and the timing of the rate cut could be front-loaded into July-September.
We expect the policy agenda for inflation targeting and expanded JGB purchasing to slip back beyond the July election as well. The current coalition faces the possible loss of its Upper House majority, and the shape of the coalition after the election is a key talking point. Monetary policy would only return to the agenda when the political confusion has been resolved, and we conclude that delays until the autumn or beyond are likely. However, the precedent set by the ECB's government bond purchasing operations to stabilize the market may increase the pressure on the BoJ to step up JGB purchasing when long-term yields are rising in Japan due to supply/demand concerns. Or if the government makes a credible medium-term commitment to fiscal rebuilding, a constructive scenario is possible too in which the BoJ is supportive of government policy efforts and buys long-term bonds in a co-ordinated policy. In a period of intensifying concern over supply/demand deterioration which tends to be repeated every year in early autumn, the government and BoJ may show renewed co-operation.
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DPJ Manifesto: Subtle Priority Shifts, Much More Inertia
June 21, 2010
By Robert Alan Feldman, Ph.D. | Tokyo
The new election manifesto for the ruling Democratic Party of Japan (DPJ), released on Thursday, includes several subtle shifts of priorities. There are no major shifts, however, and some inconsistencies remain. Overall, the document represents a modest shift from the left toward the center in economic policy.
That said, the fundamental problem that has plagued economic policy in Japan for the last four years - lack of balance between fiscal, monetary and structural policies - remains unresolved in the new DPJ manifesto, just as it was unresolved in the three previous LDP governments. Moreover, the lack of quantification (how much in spending cuts, how much in tax hikes, how much monetary expansion, how much regulatory reform) will leave major questions in the minds of investors about the true policy direction of the new government.
The Subtle Shifts
The new manifesto shows several subtle shifts in DPJ positions, some stated directly and others by omission.
1. The priority of macroeconomic matters is higher. In last year's manifesto, macro had no place at all; in December 2009, macro was discussed only on the last two pages of a 29-page document. In the new manifesto, macro is mentioned, in very large type, on the first page of policy discussions. (Note the manifesto starts with a personal statement from PM Kan.) The macro targets are unchanged from the December 2009 growth strategy, i.e., 3% nominal growth and 2% real growth on average until 2020. However, the language about the Bank of Japan (BoJ) is mildly stronger than that in PM Kan's policy speech of last Friday. The new language is, "The Government and the Bank of Japan [will] cooperate, and conquer deflation quickly through pursuing concentrated policy." That said, the manifesto did not take the opportunity to use the term "inflation targeting" or "amend the Bank of Japan Act".
2. The role of trade policy as part of growth strategy is more prominent. Pursuing EPA and FTA agreements with Asia is presented as a way to enhance Japanese growth; in addition, the language on "regulatory reform to liberalize and ease investment rules" is a step forward. Further, PM Kan's personal statement contains stronger language, saying, "We will pursue EPA and FTAs actively, and thus vitalize exchange of goods and people, in order to bring economic vitality, especially from Asia, into Japan." The manifesto does not use the word "immigration" anywhere. However, one might read between the lines that PM Kan is more eager to get immigration openly on the agenda.
3. The phrase "regulatory reform" is used frequently in the new manifesto - unlike in earlier DPJ debate. The new manifesto sticks to the theory, mentioned early in the document, that the regulatory reforms of the 1990s/2000s were deflationary; yet, the manifesto also advocates such reforms in a number of areas. This apparent contradiction is explained away by the DPJ, saying that the regulatory reforms they want will "create demand", e.g., in nursing care. My view is that such demand is extremely strong already; the demand remains unsatisfied because of supply-side regulations (e.g., in childcare, regulations that inefficiently separate nursery school and kindergarten regulation). In the end, it matters little whether the regulatory reforms are called "supply" or "demand" policies, as long as they allow latent demand to be fulfilled. The key thing is that the DPJ now shows keener awareness than it did last August that regulatory reform is an important way to strengthen the economy.
4. On fiscal policy, the DPJ is clear about targets for the primary deficit, i.e., bringing that deficit to zero by 2020. These targets amount to about 1pp of GDP contraction every year for the next ten years. Clarity and quantification are laudable, but there is a problem with the arithmetic: in order to stabilize the ratio of debt to GDP, simple arithmetic dictates that the primary deficit must be taken to a surplus of about 3% of GDP. Nor is there any clarity in the new manifesto about how much of the gap will be closed by spending cuts and how much in tax hikes. The call for a bipartisan commission on fiscal reform is laudable as well; however, deliberations have not started, so the degree of confidence that investors will place in the process of fiscal reform is likely to be low.
5. There is an interesting omission on the fiscal deficit. Heretofore, PM Kan has repeated that he will hold the new issuance of bonds in F2011 (next fiscal year) to JPY44.3 trillion, the same level as this year. However, the manifesto uses different language, saying, "We will make every effort to keep bond issuance in FY2011 below the level of issuance in 2010." Thus, should issuance in the current fiscal year exceed the current target of JPY44.3 trillion, the government would be free to maintain the higher level of issuance in F2011.
6. The manifesto position on employment does not include a reference to the bills recently proposed to ban use of temporary workers in manufacturing. Rather, the new manifesto says, "We will pursue work-life balance, through equalizing and equilibrating the treatment of people working in the same place and in the same job." Such a phrase could be read as a call for passage of the bill as proposed. However, the phrase may represent a change of view.
7. On childcare allowances, the new manifesto says that the party will push for increasing expenditure on childcare as proposed earlier; however, the party will not necessarily push for direct payments to families with children but rather examine expenditure on support in kind, such as increased provision of childcare facilities.
Many Problems Remain
Despite these subtle shifts, many issues and apparent contradictions remain in the DPJ manifesto, items that suggest progress towards productivity growth and demand increase will be slow.
1. There is no attempt in the manifesto to bring all of the micro policies into a consistent macro framework. For example, how will it be possible to reconcile child support, pension maintenance, better medical care, spending cuts, tax hikes and faster growth? How much in spending cuts, how much in tax hikes, how much in monetary expansion, how much regulatory reform are needed to meet the goals? Indeed, there are virtually no numbers in the new manifesto. This lack of quantification leaves huge uncertainty about the feasibility of implementing all of the policies.
2. There are inconsistencies in individual policy areas. For example, the pages on economic policy (p. 5-6) include vague references to use of IT in medical fields, but the page on medical policy (p 14) has nothing on the matter. This suggests the interactions of macro and micro were not fully worked out; the political economy of such inconsistencies may suggest that different interest groups backing the DPJ have different interests, leaving policy unclear. Moreover, the new manifesto implies backsliding in some areas. For example, the 2009 Policy Index of the DPJ stated clearly that the party would encourage new entrants into agricultural distribution - a field heretofore dominated by the agricultural coop system. The new manifesto includes no such reference.
3. The treatment of the corporation tax is extremely vague. A large-type title on the economics page (p 6) announces "Corporation Tax Cuts", but the substance says only that the special corporate tax on small business will be lowered from 18% to 11%. (This policy was already in the previous manifesto, but was accompanied by a tightening of the eligibility, so there might not be a net tax cut.) Moreover, the specific language in this item says, "Predicated on a simplification of the corporation tax, we will review [the corporation tax] from the viewpoints of maintaining and strengthening international competitiveness and of spurring inward direct investment." This language is very weak, compared to the presence of the corporate tax issue in the minds of investors.
4. The manifesto gives a very large-type category to "Postal Reform", and promises to give "highest priority" in the next Diet session (in the autumn) to passage of the bills to reverse the reforms of 2005-06. These bills would indefinitely postpone the public offering of shares of the Postal Bank and Postal Life companies and would recombine the postal delivery and postal network entities. Such changes would reduce incentives for efficient operation of the postal entities. Note that this element is part of the DPJ manifesto itself, not part of an agreement with its coalition partner.
5. The concept of "productivity" is not used in the new manifesto, even though PM Kan's policy statement of June 11 included at least some positive references to encouraging productivity. There are many references in the new manifesto to innovation, but the innovation is presented as a new source of demand. In an aging society where labor will become very scarce within a few years, a lack of focus on productivity would be a serious threat to maintaining living standards.
Conclusion
My conclusion is that the new manifesto displays a modest shift in DPJ thinking towards more emphasis on practical policy, such as regulatory reform, monetary stimulus and fiscal restructuring. However, the balance among these three policy areas is far from clear. Investors may well fear that the fiscal restructuring, which is necessarily contractionary for the economy, will be done first, and without enough push on either monetary or regulatory policy. If so, Japan would see a repeat of 1997-98, when spending cuts and tax hikes triggered a major contraction, exacerbating the impact of the Asian crisis. Moreover, the lack of quantification in the new manifesto leaves major questions about the net economic impact of DPJ policies.
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Can Social Housing Help Secure a Soft Landing?
June 21, 2010
By Qing Wang & Ernest Ho | Hong Kong
Fear of Hard Landing Unwarranted
Not long ago, there was widespread concern in the market of a potential hard landing for the overall economy as a result of the Chinese government's austerity measures aimed at reining in rapid property price increases not driven by genuine underlying demand for shelter. Transactions volume slumped over 30%Y in tier-one cities in the last week of May, with a few tier-two cities feeling the pain as well (see China Property Transaction Tracker, June 10, 2010). The market quickly responded by pricing in a significant slowdown in property transactions, construction and investments, effectively factoring in the possibility of an aggressive macro tightening that would lead to an economic hard landing.
While we have long argued that the negative reaction of the market is overdone (see China Economics: Moderation in Activity; Reflation; and Policy Normalization, May 11, 2010), we showed in our previous report that the tail risk is in fact not as significant as many expected even in the extreme scenario where commodity residential building construction activities were to experience serious disruption in cities with property prices perceived to be ‘too high' and have been rising ‘too fast' (see China Economics: Can Recent Policy Campaign Against Property Speculation Cause a Harding Landing? May 24, 2010).
In our estimation, residential commodity housing in the 35 largest cities accounted for about 15% of total construction activity nationwide in terms of floor space completed, within which the cities of ‘top 10 price gainers' and ‘top 10 highest price' were only 5% and 6% of grand total, respectively. The four tier-one cities, where both property prices and transactions are expected to be the hardest hit, represented only 3% of total floor space completed nationwide.
Hope of Soft Landing Rising
With the tail risks on the downside now hopefully thoroughly analyzed and understood, the central government's ambitious social housing construction plan came just in time, offering the much-needed offset to a potential slowdown in residential property sector construction that has yet to show any sign of abating.
Indeed, the social housing construction program is attractive in many ways, as it meshes well with the authority's long-term goals of achieving the greater good of wealth redistribution in addition to strengthening economic growth by encouraging social investment, enhancing employment opportunities, and promoting the development of community facilities. After all, in Chinese society the importance of owning a property cannot be overstated as it has now almost become an integral part of the country's deep-rooted traditions, even though the affordability of housing might not have caught up with the recent rapid rise in property prices. Further, the construction of social housing is part of fixed asset investment, consuming the same type and amount per unit of construction materials as commodity housing, and it generates the same amount of value-added per unit of output.
Therefore, given the urgency and desirability of promoting more affordable housing, the big question is, how much can the expected acceleration in social housing projects contribute to the overall construction activity? And further, will it be significant enough to cushion the potential slowdown stemming from the deceleration in the commodity housing space? We attempt to address these questions systematically by breaking them down into three separate analyses.
Analysis I: A Robustness Test of Our Forecast of Construction Activity
The most important factor affecting FAI in general - and real estate construction in particular - in China is availability of bank credit, in our view. The new loan target of Rmb7.5 trillion for this year implies expansion of about 19%Y in the outstanding amount of bank credit. As long as this credit target remains unchanged, the probability of a hard landing of FAI growth is very low, in our view.
With 19% expansion in bank lending, we forecast FAI growth to be 20-25% in 2010: while this is a deceleration from the high level of 32% reached in 2009, it is far from a hard landing. Of particular note, the expansion of medium- and long-term loans, which are primarily used to finance FAI, is substantially stronger than overall loan expansion. This is because short-term loans extended in 2009 - in part reflecting banks' effort to expand their loan books when credit controls were eased - are being converted into medium- and long-term loans in 2010, as more projects are available to finance.
By examining the historical relationship between loan growth and expansion in floor space construction, we estimate that total floor space completed will increase by 10-15% this year, given about 19% expansion of outstanding amount of bank credit in general and about 30% expansion of medium- and long-term loans in particular.
How robust is this forecast of construction activity under the top-down approach (i.e., expansion of total bank credit)? Is this forecast consistent with potential acceleration in social housing construction and the inevitable slowdown in market-based residential property construction?
What can we expect of the social housing program?
- First, according to the Ministry of Land and Resources and our own estimates, about 33% of the planned land supply in 2010 will be steered toward social housing construction, with 24% going to non-commodity residential construction (20% for slum area reconstruction and 4% to low-rent housing) and 9% to commodity residential economic housing.
- Second, with respect to construction activity, according to the Government Work Report for the Year 2010 delivered by Premier Wen in March 2010, the government's plan for 2010 is to construct 3 million units of social housing, and reconstruct 2.8 million units of slum area, in order to "satisfy the basic residential needs of the general public". It also reiterated the government's commitment to increase the land supply for small to medium-size/price commodity residential housing.
- Third, the Ministry of Housing and Urban-Rural Development (MOHURD), the National Development and Reform Commission (NDRC) and Ministry of Finance (MoF) had jointly directed the overall target to "solve the housing need for 7.47 million urban low-income households in 3 years time (from year 2009 on)". Specifically, 1.8 million, 1.8 million and 1.6 million units of low-rent housing were planned in 2009, 2010 and 2011, respectively, on top of the provision of rent subsidies.
We estimate that the construction plan for social housing, which includes slum area reconstruction and low-rent housing in the non-commodity residential housing space, as well as economic housing in the commodity residential housing space, will add up to 370 million square metres of floor space in 2010.
Now the next big question is: given the social housing construction plan for 2010, how much of a slowdown in construction activity in the commodity residential housing space can we afford in order for our aforementioned forecasts of overall construction activity to materialize?
We conducted robustness tests by taking the social housing construction plan for 2010 as given, and then assumed a year-on-year decline of 0-20% in construction activity in the commodity residential non-economic housing market (includes ‘deluxe & large size housing' and ‘small & medium-size housing' where construction and transactions are determined freely by the market with homebuyers having access to residential mortgage for financing). The result suggests that our forecast of 10% expansion in construction activity in terms of floor space would be quite achievable even if there were to be a potential 7% decline in the commodity residential non-economic housing market, given the strong growth expected in social housing construction. Based on this forecast, social housing will account for about 21% of the estimated total floor space completed in 2010.
Indeed, by historical standards, the chances of total floor space construction dropping by more than 10% are rather slim. Data suggest that even in 2008, when the commodity residential non-economic housing market was experiencing serious difficulty, total floor space under construction still grew by 15%Y, while total floor space completed expanded by 1% compared to 2007. Both jumped by more than 20% as economic conditions improved in 2009.
Analysis II: Assessing the Political Will to Achieve Targets as Planned
This Time Is Different
While the track record for social housing construction in the past few years has not been stellar, we believe that it will be different this time. The underlying reasons for the sub-optimal progress in social housing construction in the past few years were mainly inadequate capital investment and a lack of political incentives for the local governments to carry out social housing projects as planned.
In the joint directives issued by the MOHURD, NDRC and MoF, which laid out a roadmap for "solving the housing issue of 7.47 million urban low-income household in 3 years time (from year 2009 on)", local governments at both the city and the county level were required to commit capital for the construction of low-rent housing by including it in their annual budgets. In addition, all the net revenue from the Housing Provident Funds, as well as no less than 10% of land sales revenue collected, must go to the construction of social housing. Moreover, the MOHURD at the province level will take the lead in closely monitoring the progress of slum area reconstruction on a semi-annual basis. Work-in-progress reports detailing the completion of annual budget as well as planned land supply and development at the city level must also be submitted to MOHURD, NDRC, MoF and the Ministry of Land and Resources. Furthermore, the central government will arrange to provide a further Rmb63.2 billion for social housing construction in 2010, an increase of 14.8%Y compared to 2009.
The story becomes more compelling as the local governments were required to sign a "2010 social housing project contract" with the MOHURD in May to commit to completing the construction targets as planned. In addition to reiterating the importance of social housing, the agreement holds local governments accountable for the progress to completion as stipulated in the contract by the end of the year.
With such a strong commitment to meeting the target from both the central and local governments, the likelihood of a significant acceleration in social housing construction is growing by the day. Nevertheless, there is still one important issue to be addressed: who will pay for it?
Analysis III: Show Me the Money
Financing Should Not Be a Problem
Financing of social housing construction comes mainly from three sources: central government subsidies, local government subsidies and profits from selling commodity residential economic housing and the reconstructed slum area. The big question then is whether these three sources combined are sufficient to cover the construction costs of the social housing project as a whole.
Specifically, the central government will arrange to provide Rmb63.2 billion for social housing construction in 2010. Subsidies from local governments will come mainly from land sale revenue, which adds up to about Rmb1,366 billion for 2010, according to the annual budget - 10% of that would be Rmb136.6 billion. Assuming construction cost at Rmb1,000 per square metre on average, total construction cost would be about Rmb370 billion. If the commodity residential economic housing and reconstructed slum areas can be sold at a reasonable mark-up to the construction cost, say with a price tag of Rmb1,600 per square metre or above, we estimate that the total source of funds will more than offset the total cost of constructions.
Conclusion
While we do not consider a sharp slowdown in construction activity as a high-probability event for 2010, we see social housing construction projects as an important cushion for a potential deceleration in the construction of commodity residential housing. The combination of strong political will and the attendant serious financial commitment from the governments suggest that the likelihood of a repeat of the shortfall in actual versus planned social housing construction observed in the past few years is rather slim, in our view.
FAI is likely to remain buoyant due to strong loan growth for the rest of the year, as monetary conditions continue to be accommodative. The latest macro data release showed signs of a rebalancing among growth drivers (see China Economics: Moderation in Activity Points to Soft Landing, June 11, 2010), with strong exports growth reflecting the ongoing global cyclical recovery while retail sales remained robust as labor market conditions tightened and consumer confidence recovered to close to pre-crisis levels. CPI and PPI inflation will likely peak in the next couple of months, in our view. Given the relatively strong growth in the overall economy and gradually subsiding inflationary pressure, the Goldilocks scenario is still largely on track, featuring a soft landing in 2H10, in our view.
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