CEBM China Research

Thursday, July 01, 2010

Dan Zhou Robert Zhang, CFA Steve Chen Han Wang, Ph.D. Yongyuan Qiao, Ph.D.
dzhou@cebm.com.cn rzhang@cebm.com.cn ychen@cebm.com.cn hwang@cebm.com.cn yqiao@cebm.com.cn

China’s Trade Growth Likely to Decelerate 3Q and

Onward Due to Weakening Domestic and Foreign Demand

 Our CEBM China export leading indicator has already peaked, indicating that China’s
exports are likely to peak soon. Our export model suggests that China’s exports may
decelerate from 3Q due to weakening domestic and foreign demand.
 The latest Korean export data in June remained strong. Based on the evidence from both
export destinations and export products, we maintain our estimation that China’s export
is expected to grow 30% Y/Y in June.
 As the government has unofficially adopted normalization strategy away from the
stimulus we are likely to see property, infrastructure, and manufacturing investments
lose steam in the second half. The deceleration of FAI may put downward pressure on
China’s imports.

CEBM Group 1
CEBM research reports are published solely for informational purposes for qualified investors. Nothing in this report constitutes a representation that any investment strategy
or recommendation contained herein is suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal recommendation.
 China Macro

PMI from Industrial Economies Shows China’s Exports Likely

to Have Peaked
We have provided a medium-long term view on China’s exports in the semiannual macro
report. Based on our model China’s exports is likely to grow 23.6% this year, with exports
increasing 16.7% in the second half compared to 33.2% in the first 5 months.
We also have a short-term framework. The framework is based on PMI from advanced
economies, including the USA, Japan, UK, Canada, and Eurozone. The advantages of this
leading indicator are: (1) PMI for these economies is released at the same frequency with
exports, and (2) these economies account for 61.9% of China’s total exports. This is an
understatement, as the most part of Hong Kong’s re-exports go to these economies as well
(13.8% of China’s exports go to HK).
Although PMI of these economies tend to move to the same direction, this is not
necessarily the case. To give a more exact overview, we have normalized the original
headline PMI for each economy, and then we have summed up the real-GDP weighted
PMI series, whereby the weights are reset for every year.
Unfortunately, the leading indicator has a relatively short history due to the data
availability of the Euro zone. However, the indicator does lead exports remarkably when
the data is available. More important, the leading indicator have peaked recently,
indicating that China’s exports are likely to peak in 3Q, which is in line with our results
derived from the medium-long term model.

Chart 1PMI of Industrial Economies

75
US Canada UK Eurozone Japan
65

55

45

35

25
06/03 07/03 08/03 09/03 10/03

Source: Bloomberg
Chart 2 CEBM Leading indicators Have Already Peaked
70% China's Exports (Y/Y) 2
Leading indicator(RHS)
50% 1

30% 0

10% -1

-10% -2

-30% -3
06/03 07/03 08/03 09/03 10/03
Source: Bloomberg, CEIC, CEBM Group

CEBM Group 2 2010/7/1

 China Macro
Robust Korean Exports Indicate China’s Exports May Remain
Strong in June
As we mentioned in previous reports, Korean export data can often be used to predict
China’s exports due to a high content of processing trade between the two economies. In
the first 20 days of June, Korean exports increased 32.4% Y/Y. The exports to the Latin
America, EU, and Hong Kong gained the most. As those economies are traditionally
major China’s export destination as well, we believe China’s exports are likely to remain
strong in June.
It is worth noting that the growth rate of Korean export to China fell below average. Since
about 50% of Korean exports to China are processing imports, the slowdown of Korean
exports to China will show up in China’s export with a time lag.
A closer look at the breakdown of Korean exports shows that growth momentum of color
TV, electronic parts, and semiconductor is still strong. Export momentum of light industry
goods, like plastic and textile, remained largely unchanged. As all those products also
make up a significant part of China’s exports, it is highly likely that China’s export growth
may stay at an elevated level.
Based on the above evidence from both export destination and products, we maintain our
estimation that China’s export in June is expected to grow 30% Y/Y. The latest PMI in
advanced economies slid further, indicating that foreign demand may have peaked. This is
likely to put downward pressure on exports. We maintain our estimation that China’s
export is likely to decelerate significantly from 3Q.
Chart 3 Infrastructure and Housing Investments Estimation (%, Y/Y)
40% 80%
30% 60%
20% 40%
10% 20%
0% 0%
-10% -20%
-20% -40% Korean exports to China (3mma, Y/Y)
China's exports (3mma, Y/Y)
-30% Korean exports (3mma, Y/Y) -60% China's exports (3mma, Y/Y)
01 02 03 04 05 06 07 08 09 10 01 02 03 04 05 06 07 08 09 10
Source: CEIC, CEBM Group
Chart 4 Korean Exports to US and EU Slightly Above Average
180 140
Exports to EU (sa 2007M1=100) Exports to USA (sa 2007M1=100)

140
100
100

60 60
07 08 09 10 07 08 09 10

Source: CEIC, CEBM Group

CEBM Group 3 2010/7/1

 China Macro
Significant Drop in Investments Due to Stimulus Withdrawal
Puts Downward Pressure on Imports
As China became more comfortable with the recovery in the first half, the government
started to withdraw the fiscal and monetary stimulus gradually. Although China remains
cautious about the strength of economic recovery, the government indeed has already
begun an exit strategy in almost all areas touched by stimulus, including (1) Loan quota
controls, (2) Tight measures on property market, (3) Stricter regulation on LGFVs (local
government financing vehicles), (4) Resumption of exchange rate reform, and (5)
Reductions in export rebate. The only major lever untouched is interest rates.
Investments, which helped China defend from the crisis in 2009, are likely to lose steam
due to base effect. Morever, the stimulus withdraw may put additional pressure on the
investment growth. Based on our estimation, both infrastructure investments and housing
investments are likely to decelerate significantly – they account for 28.1% and 22.2% of
total FAI in 2009, respectively. Manufacturing investment, which made up more than 30%
of FAI, may be negatively affected by the uncertain outlook. As a result, the FAI is likely
to slow down. Under the base case, the Y/Y growth rate of FAI may decline to 21% from
31% in 2009.
Since a significant part of China’s imports is used to meet the investment needs, the
deceleration of FAI may put downward pressure on China’s imports.

Chart 5 Infrastructure and Housing Investments Estimation (%, Y/Y)

60 Infrastructure investment growth 40 Housing investment growth
Base case estimation 35 Base case estimation
50
30
40 25
30 20
20 15
10
10 5
0 0
05/03 06/03 07/03 08/03 09/03 10/03 05/03 06/03 07/03 08/03 09/03 10/03

Source: CEIC, CEBM Group

Chart 6 CEBM FAI (Fixed Assets Investment) Forecast (%, Y/Y)
40
Base case Optimistic Pessimistic
35
30
25
20
15
10
05/03 05/09 06/03 06/09 07/03 07/09 08/03 08/09 09/03 09/09 10/03 10/09

Source: CEIC, CEBM Group

CEBM Group 4 2010/7/1

 China Macro
Watch China’s Commodity Demand for Imports in 2H10

As mentioned above, China’s imports is likely to decelerate in the second half as harsh
Major measures takes effect gradually. Imports can be broken down into processing imports and
commodities ordinary imports, so the impact of decelerating domestic demand can be analyzed
include: rubber, separately. Processing imports are by nature affected mainly by the foreign demand. In
iron ore, copper contrast, ordinary imports reflect true Chinese demand.
ore, coal, crude Major commodities are the dominant component of ordinary imports, with the share
oil, refined reaching as much as 40%. Since 2003, the share of major commodities to total ordinary
petroleum, imports showed a clear upward trend. Although both the seasonally adjusted commodity
copper waste, etc. imports and the processing imports have almost reached the pre-crisis high, the
commodity imports have been more volatile, suggesting once again that the commodity
imports are much more important in determining the direction of China’s imports.
It is worth noting that volatile import items, like aircrafts and ships, remained largely
stable and not at all significant in affecting total ordinary imports, which is against market
expectation. The share of volatile imports remained around the historical average and
stayed at a low level. Motor vehicles account for 80% of the value and excluding them
would result in a negligible number.

Chart 7 Volatile Imports Remained Stable (but Insignificant)

12% Contribution of volatile imports(excl.auto)
Volatile imports: Volatile imports/ordinary imports Contribution of auto
Locomotives, 10% Ordinary imports (LHS,Y/Y)
100% 8%
Motor Vehicles, 80%
8% 6%
Aircrafts, and 60%
ships. 40% 4%
6%
20% 2%
4% 0%
-20% 0%
2% -40% -2%
01 02 03 04 05 06 07 08 09 10 05 06 07 08 09 10
Source: CEIC
Chart 8 Major Commodities Imports Take Lion’s Share of Ordinary Imports
260 Major commodity imports 50%

220 Processing imports (sa 2007M1=100)

40%
180
30%
140
20% Major commodities
100
imports/ordinary imports
60 10%
07 08 09 10 01 02 03 04 05 06 07 08 09 10

Source：CEIC, CEBM Group

CEBM Group 5 2010/7/1

 China Macro
Daily China A-Share Market Review
 China’s stocks continued the downward trend to fall by 1.02%, with the benchmark
index ended at 2373.79. Transaction volume also shrank to 46.4bn yuan. Pharma,
telecom and coal declined the most. Investor sentiments remained low as the newly
released PMI is lower than the market consensus.
 China's manufacturing PMI stood at 52.1% in June, down 1.8% points from last
month. 10 sub-indices such as production, new orders and purchasing prices all fell,
but the overstock index was up.
 Rumors say Shenzhen Development Bank (SDB) will fund the acquisition of Ping
An Bank through a private placement of 1.5 bn shares to Ping An Insurance (Group).
Upon the completion of the transaction, Ping An Insurance (Group) is expected to
hold a 51% stake in SDB.
 MOHURD (Ministry of Housing and Urban Rural Development) called for
accelerating the development of information network system and database for private
housing registration to facilitate the property control.
 The average transaction prices of new homes in Shenzhen fell 10.63% M/M to
16,978 yuan per square meter in June, reports secutimes.com.
Chart 9 Shanghai Composite Index Chart 10 Daily Best/Worst Performers
3400 Trading 250 Petrochemical -0.13
3300 Value/ bn
3200 200 Bank -0.41
3100
3000 150 Auto -0.45
2900 -2.02
Coal
2800 100
2700 Telecom -3.14
2600 50
2500 Pharma. -3.45 %
2400 0
10/01 10/02 10/03 10/04 10/05 10/06 -4 -3 -2 -1 0
Source: Wind Source: Wind, CEBM
Chart 11 1-Month Best/Worst Performers Chart 12 A-H Premium Index
Property -4.47 170
160
Power -4.67
150
Constr. -4.86 140
130
Coal -15.22
120
Pharma. -16.08 110

Non-ferrous -16.17 100

%
90
-20 -15 -10 -5 0 09/01 09/04 09/07 09/10 10/01 10/04
Source: Wind, CEBM Source: Bloomberg

CEBM Group 6 2010/7/1

 China Macro
Daily China Fixed Income Market Review
 The government bond index declined 0.02%, ending at 125.63, while the corporate
bond index dropped 0.03%, closing at 141.55. On the money market, the 7D Shibor
rate and repo rate dropped sharply, signaling the liquidity situation has started to
ease. On the FX market, the RMB climbed to 6.78, while the reference rate was set at
6.7858. The 12M NDF increased to 6.67, signaling the appreciation expectation is
getting stronger.
 The PBOC issued 22 billion yuan in 3Y central bank bills at a yield of 2.68%. As a
result, the central bank injected 67 bn into the interbank market.
 China may launch a mini-QFII as soon as this year. Under this scheme, Hong Kong
subsidiaries of domestic brokerages and fund managers are allowed to facilitate
investments of offshore yuan deposits back into mainland capital markets.
 At least nine Chinese provinces and cities will raise minimum wages from Thursday
by as much as 33%.

Chart 13 Govt & Corp Bond Index Chart 14 Shibor Rate (%)
126 Government Bond 144 3.4 1W 3M
3.2
125 Corporate Bond (RHS) 142
3
140 2.8
124 2.6
138 2.4
123
136 2.2
122 2
134 1.8
121 132 1.6
1.4
120 130 1.2
09/08 09/11 10/02 10/05 10/01 10/02 10/03 10/04 10/05 10/06 10/07
Source: Wind Source: Wind
Chart 15 Interbank Market Repo Rate (%) Chart 16 Yield Spread (bps)
3.5 4.5 Spread (RHS) 190
O/N 7D
5Y Corporate (AAA) 180
3 4 5Y Government 170
160
2.5 3.5
150
140
2 3
130
2.5 120
1.5
110
1 2 100
10/01 10/02 10/03 10/04 10/05 10/06 10/07 10/02 10/03 10/04 10/05 10/06 10/07

Source: Wind Source: Wind

CEBM Group 7 2010/7/1

 China Macro

Disclosure: CEBM research reports are published solely for informational purposes for qualified investors.
Nothing in this report constitutes a representation that any investment strategy or recommendation contained
herein is suitable or appropriate to a recipient’s individual circumstances or otherwise constitutes a personal
recommendation.

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CEBM Group 8 2010/7/1