For the last 12 months we've been thinking about how China impacts the rest of the world, and have consistently highlighted one forward-looking theme: bullish upstream, bearish downstream. Or, to be more precise, bearish on downstream basic materials processing sectors, sanguine on upstream mining and fuels – and very, very bullish on agriculture.
The logic of the call was clear. Regardless of demand momentum, you want to be short in areas where China is long, supply-wise, and long in areas where China is short. The only trouble is, these are fundamental medium-term trends, and we never knew when the forecasts would hit. But now it looks as if the ship is coming in. On all three counts. In fact, the numbers so far point to an economic "perfect storm" brewing on the commodity and basic materials front.
Overall, imports have been slowing in line with aggregate demand in the economy – no big surprises here. What is surprising, however, is the sharp divergence between individual commodity groups. In volume terms, metals imports have been collapsing, and chemicals purchases are already flatlining. Meanwhile, imports of minerals and fuels are holding up very well, with no signs of a significant slowdown. And agricultural imports … well, they're speeding month by month. How long will this go on? Obviously there's still a good bit of volatility yet to come, and we won't be surprised if the numbers turn around somewhat in the months ahead. But we suspect that come this time next year that perfect storm just might have hit home. (December 13, 2004)
Washington, DC-based G7 Group on how Beijing sees 2005
After the Central Committee of the Communist Party of China and the State Council held a three-day meeting in late November to map out key economic goals and policies for 2005, a communiqu? was issued, causing G7 Group to observe: "Like Fed Chairman Greenspan's rhetoric, the official standard line of Chinese policymakers is, by intention, often hard to interpret." Other comments:
How long will macro adjustment stay? As the communique pointed out, "all comrades of the party should fully appreciate that macro-adjustment is necessary, long-term and challenging." We read this as an endorsement from the apex of the Communist Party of the administration's economic policies, since the party deems macro adjustment a concrete form of revamping the party's governing power. So, macro adjustment has also become party propaganda, and it's going to stay for a long time.
What does "prudent" mean regarding monetary policy? As Wu Xiaoling, deputy governor of the PBoC, stated in Beijing on Nov. 30, the "discrepancy between the growth of M2 and the sum of GDP growth and headline CPI likely will be further narrowing going forward." We read this as a signal that money and credit supply likely will stay tight in 2005. Since controlling the excessive growth of fixed-asset investment and stabilizing prices are the short-term focus of macro-adjustment, we have adequate reason to believe that monetary policy will have a moderately tightening bias in 2005. The communiqu? also emphasized the role of "market mechanisms and the economic approach in allocating resources," which we read as a sign that moderate interest rate hikes at a measured pace (likely no more than 100bp) are possible in 2005.
Why didn't the communiqu? mention forex reform?
At this sensitive market juncture, it's wise not to add fuel to speculation. As China's senior leaders have emphasized again and again, a speculative environment and international pressure can only be counterproductive in terms of speeding up China's reform of forex regime. We have noticed with interest that the most recent report from the US Treasury Department to the Congress concluded again that China didn't manipulate its currency, and instead highlighted the groundwork that China had laid down in order to move towards a more flexible forex regime. We believe that report recognizes that inflaming the environment will not speed reform, but would only slow it. The communiqu? stated that China will further deepen "financial system reform" in 2005, and in our view, that includes reforming China's forex regime. (December 7, 2004)