China: The Great Shift Forward

Conclusion: After a series of shrewd moves by the government which have centered on raising domestic consumption, China is positioning itself as a defensive play in late 2010 and heading into 2011.

 

Here’s what we know – growth in China is going to slow. After posting +11.9% Y/Y 1Q GDP, calling for a sequential erosion from here in the midst of a sovereign debt scare in Europe which has eroded the purchasing power of China’s largest export market isn’t exactly a tough call to make. The government even said on Friday that their full year growth estimate is 9.1%, explicitly implying a deceleration from 1Q. With the Shanghai Composite down 27.3% YTD as of today, prices confirm this. Using marked-to-market prices as leading indicators, however, Chinese equity prices have been telling us to expect slowing growth all year long.

 

At a price, China’s growth will become attractive on the long side irrespective of slowing growth in the U.S. and in Europe because their government is proactively preparing them to weather the storm by fueling domestic consumption. Over the past several weeks, China has taken a number of steps to increase their citizenry’s purchasing power – none arriving with more fanfare than the de-pegging of the yuan.

 

Since relaxing the fixed exchange rate on June 19th, the yuan has gain roughly 0.7% vs. the dollar and today’s 12-month non-deliverable forwards suggest an appreciation bet of roughly 1.5% in a year’s time. Despite the prospects of a stronger currency, the People’s Bank of China has ruled out any sudden large appreciations and still mandates that the currency only fluctuates 0.5% from the daily official rate. As a result, we caution that the yuan’s appreciation may not likely be the silver bullet China is looking for to stimulate domestic consumption, which has fallen from 46.4% of GDP in 2000 to 35.6% of GDP in 2009. As a percentage of GDP, personal income has had an even more dramatic decline: 53% in 1999 down to just 39.7% in 2009.

 

There have, however, been a number of positive developments regarding wage growth and government stimulus that will help move China forward towards a more consumption-oriented economy, rather than one that has been fueled by manufacturing and exports in recent years. Those developments are listed below and are by no means limited to this summary: 

  • In April, Shanghai raised minimum wages 17% to 1,120 yuan per month. Guangdong (China’s largest export base) took up minimum wages in five locales within the province by an average of 21%.
  • On June 3rd, China extended its home appliance trade-in program until 2011. Sales of such appliances have reached 54B yuan and 5B yuan of subsidies were handed out since the start of the program.
  • On June 8th, a survey of Chinese employer’s hiring  plans reached a six-year high.
  • On June 11th, the IMF reported that the surplus of rural workers for labor-intensive work has fallen to about 25 million from roughly 120 million in 2007, which is bullish for wages in that sector (less supply). Conversely, research from China International Capital Corp. that suggests that 31 million Chinese will return to the labor market in 2011 after the completion of projects resulting from the government’s 4T yuan stimulus package. Net-net: supply of labor-intensive workers is still shrinking but perhaps at a slower rate, which is net bullish for wages.
  • On July 1st, Bejing increased monthly minimum wages by 20% to 960 yuan. In a similar fashion, Henan (China’s most populous province) raised its minimum wage by 33% to 600 yuan per month. 

All told, more than 20 provinces and municipalities plan to increase minimum wages this year, according to the Ministry of Human Resources and Social Security. As a result, we should begin to see evidence of accelerating domestic consumption in the coming months. Furthermore, companies that are positioned to service the Chinese local economy (i.e. domestic retailers and savings deposit institutions) will see an added kick from this wave of wage inflation.

 

Currently, both the Shanghai Composite and Hang Seng are broken from a TREND perspective and last Tuesday’s 4.3% and 2.3% respective declines in both indices on the heels of a downwardly revised Conference Board Leading Index suggest that consensus still has some ground to cover on the slowing Chinese growth story. When consensus finally catches up, our Hedgeyes will be looking to buy their capitulation on sale.

 

Darius Dale

Analyst

 

China: The Great Shift Forward - Yuan Consumption


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