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July economic data presents a dilemma on tightening

Concerns of an economic cool-down in China were validated by the July economic data, but worries about price inflation will likely keep policymakers from any meaningful loosening of the tightening measures put in place earlier this year. Given the dilemma, we expect China to rely on policy fine-tuning rather than any drastic measures in the next few months to keep the economy on track.

The major growth engines of fixed asset investment, retail sales, and exports still maintained double-digit-rate year-over-year increases in July, but the pace of expansion continued to moderate (see data table below). Speculation-fighting policies in the property market and a cleanup of local government funding platforms slowed investment flowing into real estate and infrastructure construction. Industrial output growth slowed to 13.4 per cent in July, the fourth month of consecutive decline. Capacity cuts in some energy-guzzling industries are certainly to blame, but we believe a less promising outlook in the coming months also contributed to the production scale-back at manufacturers. Year-over-year comparison in monthly power usage, a good gauge of industrial activities, remained in the teens, but growth has decelerated since April.

July was a record month in terms of exports, but it was the unexpectedly low year-over-year import growth that grabbed all the headlines. Imports in July grew at only 22.7 per cent year over year, the slowest pace since October 2009 and sharply lower than the 34 per cent rate reported in June. If the trend takes hold, sluggish import growth could point to lower confidence among both manufacturers and consumers. Exports grew by 38.1 per cent year over year to $146 billion in July, but the pace continued to slow since May. We think that the strong numbers in July could be padded by exporters that rushed to ship goods out before tax rebates expire in July and that a further slowdown in export growth is likely in the second half as orders from the EU and North American markets start to fall.

Consumer price inflation ticked up in July as we expected, rising by 3.3 per cent year over year, at the fastest pace since October 2008. Severe flooding in the southern provinces destroyed crops and disrupted grain supply, pushing up food prices that account for a third of China's CPI. The government recently announced tough measures to clamp down on speculation in food supply and released grain reserves into the open market, but we think food prices may remain at elevated levels in the next few months. Higher labor costs may also exert pressure on retail prices. The good news is that wholesale price inflation continued to ease in July; prices were up 4.8 per cent compared to 6.4 per cent in June and 7.1 per cent in May, thanks to lower basic material prices.

July Major Economic Data

Source: National Bureau of Statistics, Morningstar

CPI and PPI

Source: National Bureau of Statistics, Morningstar