China starts New Year with Goldilocks economy

China’s economy has started the new year in a so-called Goldiocks state with the country’s latest inflation data delivering signs that President Xi Xinping’s efforts to manage financial risk without sacrificing growth are working in the short-term.

However, economists warn there are still predicting challenges maintaining financial stability in China in the longer term as the economy transitions from a services and consumer-led economy after years of volatility. China’s slowing property market and high debt remain areas of concern.

Encouraged by the free-fall in the US dollar, China’s central bank has also relaxed the mechanism it uses to tightly manage the local currency although it is not expected to go as far as a free-float of the yuan in the near term.

Data out Wednesday showed China’s producer price inflation slowed to a 13-month low in December as the government’s anti-pollution measures forced the closure of steel mills and factories to reduce smog during the northern winter.

The Producer Price Index (PPI), a measure of wholesale prices, rose 4.9 per cent year-on-year, slightly higher than expected. The increase compared to 5.8 per cent the previous month and was the lowest since November 2016. This has been triggered by reduced demand for raw commodities such as coal and iron ore which power China’s factories.

Economists told The Australian Financial Review the relatively stable inflation data showed China was on track for another year of solid growth but the real risk would be in 2019 as investment growth slowed.

“If PPI stays positive that is good for corporate profits and the whole system works pretty well. If PPI falls close to zero then things look a lot more dicey,” Arthur Kroeber, managing director of Gavekal Dragonomics said.

“Most likely they will be able to get through another year with approximately the same level of growth despite the fact that property sales are now falling. Construction volumes are still decent and that will prop up the heavy industrials. This year we are comfortable things will be ok and the main risk will be if you have a much sharper slowdown int he property market than anticipated.”

“The real risk emerges when you look beyond this year because there is a real and ongoing problem that investment growth has slowed down steadily and private sector investment continues to be weak”

The data from the National Bureau of Statistics released on Wednesday also showed consumer price inflation for the world’s second biggest economy rose 1.8 per cent in December, driven by price increases for fresh fruit and eggs. This was lower than economists’ forecasts of 1.9 per cent and compared with 1.7 per cent in November.

The producer inflation data confirms the impact of the government’s efforts to tackle winter smog in many of the countries’ cities, a move being closely watched by Australian coal and iron ore exporters as it impacts China’s demand for raw materials. However, economists in China are confident this will not impact demand for Australia’s high-grade commodities.

“Demand for iron ore could moderate a little big but the most important thing is China still needs high quality Australia iron ore. I don’t think Australia needs to worry about China’s demand slowdown.” Zhou Hao, senior market economist at Commerzbank, said.

CPI for the year ending December rose 1.6 per cent and PPI increased 6.3 per cent over the 12 months. This was the first year of PPI growth following a continual decline from 2012 to 2016. The consumer inflation data remains well below the Chinese central bank’s target of 3.0 per cent.

Markets are also following reports that China has changed the regime it uses to manage the local currency, which has benefited from the decline in the value of the US dollar. China has reportedly removed the counter-cyclical adjustment factor, a component of the formula to control the yuan although analysts do not yet believe the country is back on track to a currency free float in the short term. Economists said

Lian Ping, chief economist at China’s Bank of Communications, said while the central bank was unlikely to remove the mechnaism permanently it could set it to zero during a period where there were no major big currency fluctuations. He also said factory closures would continue in 2018 given environment protection was one of the government’s top priorities.

China will release its fourth-quarter GDP numbers on January 18. China needs to keep growth above 6 per cent for the next three years if it is to fulfil its goal of doubling per capita income in the decade to 2020.

The latest economic data is a promising sign that Beijing can deliver on its efforts to sustain economic growth while managing financial risk.

“We have been talking abut China risk for a long time but nothing has really blown up seriously. At the end of the day China strikes a balance between debt and growth. I don’t think this kind of extreme scenario could happen, Mr Zhou said.

Markets are also following reports that China has changed the regime it uses to manage the local currency, which has benefited from the decline in the value of the US dollar. China has reportedly removed the counter-cyclical adjustment factor, a component of the formula to control the yuan although analysts do not yet believe the country is back on track to a currency free float in the short term.

Lian Ping, chief economist at China’s Bank of Communications, said while the central bank was unlikely to remove the mechanism permanently it could set it to zero during a period where there were no major currency fluctuations. He also said factory closures would continue in 2018 given enviornment protection was one of the government’s top priorities.
Source: Australian Financial Review

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