Postcards From China

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- Macquarie visits six Chinese cities - Finds a lack of stress - Canton Trade Fair figures down - Analysts see only modest 2013 export growth

By Greg Peel

The Chinese economy appears to have stabilised from its more rapid than expected slowdown over 2012, if iron ore prices and recent PMI data are anything to go by. Yet aside from expectations of fresh policy stimulus in the new year from a new regime, the jury is still out on just what level of GDP growth China may be able to post in 2013. With official figures from Beijing being rubbery at best (including GDP results), analysts have for a while now found it best to go and see for themselves and talk to those at the coalface.

Last week Macquarie hosted two commodity-focused tours of China, visiting six cities and meeting over 40 different market participants, and the analysts have reported back with their findings.

In general, Macquarie has emphasised that there were "no signs of stress"evident for China's macroeconomic outlook. In previous trips the locals have been hanging out for government intervention but this time around their expectations were low. Macquarie takes this as a positive as it suggests China is now weaning itself off government stimulus. The general feeling was that the Chinese economy had troughed and 2013 would see improvement, if only marginally so. With the urbanisation trend and employment metrics remaining strong, further immediate policy inputs are not required, Macquarie notes.

The regime transition is nevertheless front of mind in China, but there is no impression of a policy vacuum in the meantime. The transition is nevertheless restricting explosives use in the mining sector, and there is a level of policy uncertainty which is causing a vacuum in the corporate sector. Producers are presently less willing to invest in the future than they have been over the past decade.

Destocking over the June and September quarters impacted on industrial output over this period but most of those the analysts spoke to saw this trend as now turning, offering a more normal December quarter. The only issue here is that 2012 began with a flourish in China, suggesting the March quarter data will struggle not to seem disappointing by year on year comparison.

Inflation remains a concern, given prices rose over the September quarter. However, expectations are that food price inflation will be modest over the next 3-6 months allowing room for the government to announce measures to bolster growth if required.

If the locals have now learned that all does not rest on government support, they have otherwise come to appreciate the necessity of reform, Macquarie found. The feeling is that if the current model does not change, growth will stagnate. As to what particular reforms need to be made, the locals had mixed views, Macquarie notes, although there is an assumption the new regime will prove to be pro-reform.

The Macquarie analysts would specifically like to see reforms for state-owned enterprises. The tours confirmed that SOEs have added too much excess capacity during the growth years and are now struggling for profitability.

The area which continues to look much healthier, Macquarie found, is infrastructure. Signs of of the impact of increased spending in the second half are beginning to emerge in the steel and cement sectors, although not yet in copper, the analysts noted. Steel sector overcapacity was nevertheless a key theme. This situation will take a while to play out, Macquarie suggests, and should drive below-trend investment in the coming 2-3 years.

In terms of commodity pricing, traders were generally positive on steel raw materials (iron ore, met coal) in the near term, with steel prices also supported. The reasons offered were that raw material inventories are low while steel output is returning, and that the liquidity being pumped into the system by the government is helping sentiment. Traders are targeting US$130-135/t for iron, Macquarie notes (current spot US$121/t), and perhaps even more percentage upside for met coal.

Thermal coal and aluminium are more likely to face multi-year overcapacity and zinc production is only now started to be reduced with zinc smelters having lost money for the past 18 months. The demand for zinc concentrate has remained weak, while by contrast demand for lead concentrate has been strong for the past six months. Nickel capacity is also increasing sharply but production will depend on the availability of high grade ore from Indonesia, Macquarie found.

The copper picture, the analysts conclude, is mixed.

Having a wonderful time, wish you were here.

The Canton Trade Fair is the world's largest trade fair, is held twice a year (in spring and autumn), and is considered a barometer of China's ongoing export growth. The fair wrapped up over the weekend, and delegates from Citi and BA-Merrill Lynch both noted a fall in export deals. The Canton Trade Fair signals challenges for China's exports through the first half of 2013, Citi declares.

This autumn fair saw a fall in the volume of exports of 9.3% compared to the dollar figure of the earlier spring fair, Citi notes. A 36% drop in exports to Japan, post the argument over rocks in the East China Sea, was most striking. Official trade date noted a rebound to 9.9% export growth in the month of September, which Citi presumes could be due to the Christmas factor. The analysts estimate single digit export growth in 2013.

China's exports are undergoing a structural change, Citi notes. Aside from the clear drop in trade with Japan, exports to the EU and US are falling sharply while a lesser decline was posted in exports to other BRIC and ASEAN countries. There is also a clear shift away from low value-add, labour intensive commodities to high value-add commodities (perhaps suggesting a maturing of the Chinese export industry in the same vein as Japan's decades ago).

On Merrills' measurements, the autumn fair marked a 13.8% drop in export orders signed year on year following a 2.3% yoy drop at the spring fair. This threw a bit of cold water on investor confidence, Merrills suggests, given a Chinese economy otherwise showing signs of improvement. However, the analysts see no sign of China losing its global export competitiveness and do not expect negative export growth in 2013.

Export growth will nevertheless remain sluggish, but Merrills wonders whether the Canton Fair has begun to lose some of its bellwether status. A look back through recent history shows the numbers suggested at the fair are trending below actual export growth data. Merrills suspects an increasing number of deals are now being concluded through channels other than the fair and that the numbers reflect the lower value-add of the concentration of fair products, including textiles, clothing and home appliances.

Merrills also suspects the turn-out at this autumn fair may have been particularly impacted by recent Sino-Japanese conflicts.

That said, Merrills' export growth forecasts for China of 7.5% in 2013 (following 7.3% in 2012) are in line with fair indications, the analysts find. The analysts see early signs of stabilisation and do not expect a "real collapse" in exports.

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