February CPI & PPI data released by the National Bureau of Statistics in China last night showed a continued decline in price inflation with Consumer Prices declining on a year-over-year basis for the first time since 2002.
CPI registered at -1.6% in February, making the specter of deflation a real concern for Beijing. In stark contrast to the pre Olympic period last year, the most recent data shows that collapsing commodity prices has reversed food cost trends, while non-food prices have come in much more modestly (see below).
The dilemma facing the leaders remains how to coax consumers to loosen their purse strings in the face of steady declines at the cash register. Premier Wen Jiabao has recently reiterated the government inflation target of 4% for the year, with expectations that prices will rise as stimulus program projects get under way. Last month we underscored the overlapping cultural and economic incentives for Chinese consumers to save rather than spend in the near term, nothing has changed in this analysis. The middle class have been jolted by factory job losses and the volatility in asset prices globally (a first taste of the negative side of capitalist consumer culture for many). We expect that these more affluent consumers will wait for confirmation that prices have stabilized before re-entering the market for larger purchases.
They may not wait long: As infrastructure projects break ground in central regions, streams of laborers will be drawn into the interior (instead of toward coastal factory towns as in years past) creating new geographical pressures on consumer products that could lead to pockets of regional inflation. Anyone who remembers 7th grade history class will recall the tiny pockets of hyper inflation driven by gold rush prospectors swelling the population in distant outposts. We will be watching for any anecdotal evidence of any regional pressure as construction begins in earnest in the coming months.
The falloff in prices for energy commodities and base metals continued in February, driving PPI to -4.5% Y/Y, its lowest Y/Y levels since March 2002. The breakout in component costs in the NBSC stats still show no signs of the reflationary clues we have been tracking in base metal prices and Australia/China shipping costs.
Coal was the notable divergent component again, increasing by 18.7% Y/Y, up from 12.3% in January. Last month we noted that announced production cutbacks of as much at 20% by generators on the state electricity grid would likely have an impact. It didn’t.
The PPI puzzle remains. If coal cost pressure remains strong and is joined by increased cost in other raw materials in the March data then it can be taken as a reflationary signal showing remerging demand by heavy industry. Until then, the best clues we have are anecdotal reports and price action in the international commodity markets.
We have been bullish on China consistently since December of 2009 and remain so – we are long China via the CAF closed end fund. Find us another country with positive mid single digit GDP growth and negative low single digit consumer price inflation, and we’ll show you another country we get bullish on!
China has liquidity and the potential for massive growth in domestic demand; we will remain flexible and will change our stance if the data undermines our conviction, but for now those factors dominate our model.