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Takeaway: Chinese firms are goosing exports to drive incremental liquidity into the banking system – a phenomenon that appears set to slow from here.

SUMMARY BULLETS:

  • It is our view  that Chinese enterprises are goosing their export statistics to mask capital inflows under the guise of merchandise trade shipments and Hong Kong is an obvious choice, given the cultural and operational proximity to the mainland. This tactic allows the guilty corporations to repatriate additional “earnings” back into the economy – which increases the amount of liquidity flowing into the Chinese banking system. To the extent the additional liquidity is not sterilized by the PBOC, the Chinese banking system is then able to accelerate credit growth beyond what would ordinarily be stipulated by domestic deposit growth dynamics.
  • In simple terms, this will continue until inflation becomes an issue – either actual or perceived – again. From an “actual” perspective, we don’t view a demonstrable acceleration in Chinese CPI readings as a probable event over the intermediate term, as best explained via our #StrongDollar = #StrongYuan thesis. From a “perceived” perspective, however, it’s very clear that Chinese officials remain worried about excessive liquidity fueling monetary inflation and asset price bubbles – with the former phenomenon having historically perpetuated social unrest across the mainland. Regarding the latter, the property market remains a key area of concern here. China Real Estate System data shows that average home prices across 100 cities rose +1% on MoM basis in APR (down just slightly from +1.1% in MAR and the 11th straight MoM increase) and +5.3% on a YoY basis (up from +3.9% in MAR).
  • To mitigate inflationary risks, on MAY 6, the State Administration of Foreign Exchange (SAFE) issued new regulations on foreign exchange inflows, in an accelerated effort to mitigate financial risks derived from foreign exchange receipts and payments. Specifically, the new rules will tighten limits on long yuan positions that banks can hold for their own accounts. Moreover, they are also designed to discourage firms from using dollar loans as a means to speculate on yuan appreciation. Whether or not SAFE implements and enforces its new foreign exchange regulations in an effective manner remains to be seen. It should be noted, however, that effective enforcement is a headwind for Chinese growth (particularly Fixed Assets Investment), at the margins, to the extent incremental liquidity flow to the Chinese banking system is slowed.
  • The Shanghai Composite Index (see chart below) has recently recaptured its intermediate-term TREND line ahead of the upcoming week of monthly economic data releases. In light of the recent string of macroprudential tightening measures, whether or not this is a head-fake to be ultimately faded is a key question indeed. We’ll likely know by the end of next week.

Overnight, China reported its APR Trade Data, which accelerated sequentially and surprised consensuses estimates to the upside in all three major categories (Exports, Imports and Trade Balance):

  • Exports: +14.7% YoY from +10% in MAR vs. a Bloomberg consensus estimate of +9.2%
    • To US: -0.1% YoY from -6.5% in MAR
    • To EU: -6.4% YoY from -14% in MAR
    • To Hong Kong: +57.2% YoY from +92.9% in MAR
  • Imports: +16.8% YoY from +14.1% in MAR vs. a Bloomberg consensus estimate of +13%
  • Trade Balance: $18.2B from -$0.9B in MAR vs. a Bloomberg consensus estimate of $16.2B

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 1

ONE OF THESE THINGS IS NOT LIKE THE OTHER

The “strength” in China’s Export figures for the month of APR is obviously being driven by shipments to Hong Kong, China’s second-largest export market at 15.8% of total shipments per CIA Factbook; the US is first at 17.2% and Japan is third at 7.4%.

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 2

Additionally, China’s marked acceleration in Export growth contrasts with a +0.4% YoY gain in South Korea’s APR Exports (essentially unchanged from +0.2% in MAR) and a -1.9% YoY decline in Taiwan’s APR Exports (which slowed from +3.3% in MAR). Taiwan actually alluded to cutting its 2013 GDP growth forecasts due to sluggish external demand – the same sluggish external demand that continues to weigh on Chinese PMI readings (particularly in the New Export Orders Index):

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 3

WHY IS CHINA CHEATING?

It is our view  that Chinese enterprises are goosing their export statistics to mask capital inflows under the guise of merchandise trade shipments and Hong Kong is an obvious choice, given the cultural and operational proximity to the mainland. This tactic allows the guilty corporations to repatriate additional “earnings” back into the economy – which increases the amount of liquidity flowing into the Chinese banking system. To the extent the additional liquidity is not sterilized by the PBOC, the Chinese banking system is then able to accelerate credit growth beyond what would ordinarily be stipulated by domestic deposit growth dynamics.

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 4

 

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 5

It’s worth noting that the PBOC hasn’t issued notes since late 2011 and, prior to the start of the year, had been a net provider of liquidity to the market on a trailing-3M average basis. The fact that China’s central bank has largely been a net drainer of liquidity in the YTD is likely a key driver of the recent acceleration in export goosing.

 

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 6

 

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 7

HOW MUCH LONGER WILL THIS TREND CONTINUE?

In simple terms, until inflation becomes an issue – either actual or perceived – again. From an “actual” perspective, we don’t view a demonstrable acceleration in Chinese CPI readings as a probable event over the intermediate term, as best explained via our #StrongDollar = #StrongYuan thesis. NOTE: the CNY made yet another post-revaluation record high today, trading at 6.1413 per USD.

From a “perceived” perspective, however, it’s very clear that Chinese officials remain worried about excessive liquidity fueling monetary inflation and asset price bubbles – with the former phenomenon having historically perpetuated social unrest across the mainland.

WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? - 8

Regarding the latter, the property market remains a key area of concern here. China Real Estate System data shows that average home prices across 100 cities rose +1% on MoM basis in APR (down just slightly from +1.1% in MAR and the 11th straight MoM increase) and +5.3% on a YoY basis (up from +3.9% in MAR).

To mitigate inflationary risks, on MAY 6, the State Administration of Foreign Exchange (SAFE) issued new regulations on foreign exchange inflows, in an accelerated effort to mitigate financial risks derived from foreign exchange receipts and payments. Specifically, the new rules will tighten limits on long yuan positions that banks can hold for their own accounts. Moreover, they are also designed to discourage firms from using dollar loans as a means to speculate on yuan appreciation.

Additionally, SAFE also said it will also increase scrutiny on exporters who channel money into the country disguised as trade payments, threatening to hand down a risk warning notice 10 days after it finds that a firm's capital flows do not match physical goods shipments or if the firm is channeling unusually large amounts of money into China.

Whether or not SAFE implements and enforces its new foreign exchange regulations in an effective manner remains to be seen. It should be noted, however, that effective enforcement is a headwind for Chinese growth (particularly Fixed Assets Investment), at the margins, to the extent incremental liquidity flow to the Chinese banking system is slowed.

The Shanghai Composite Index (see chart below) has recently recaptured its intermediate-term TREND line ahead of the upcoming week of monthly economic data releases. In light of the recent string of macroprudential tightening measures, whether or not this is a head-fake to be ultimately faded is a key question indeed. We’ll likely know by the end of next week.

Darius Dale

Senior Analyst

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