China: the key messages

The recovery has been consistently challenged in the year to date by stop-start investment spending, an end to the inventory rebuilding phase and soft external demand, which took a material turn for the worse in May. The majority of the data flow has underwhelmed through March, April and May. The exceptions from earlier in the year - exports (over-invoicing), housing sales (a flurry ahead of tightening), new credit (likewise, plus heavy refinancing), railways (as expected) and manufacturing investment (curious) all levelled out or decelerated in May.

Non-food consumer inflation remains relatively low and stable, while producer prices are softening anew. Policy is a heavy influence on many areas of the economy at present: SAFE and CBRC controls are driving tight interbank liquidity and a swift unwinding of disguised capital inflow, which in turn distorts the FX market; housing controls are slowing turnover; and credit data are showing signs of easing from the pace seen in Q1.

Phat Dragon maintains his basic views that

a) A low ceiling recovery-expansion remains in place, leaving one feeling a bit hollow. b) Growth, such as it is, is likely to plateau quite soon, consistent with the degree of policy accommodation having levelled off since late last year. c) The clear intent of the authorities to limit the upside has prevented a more durable upswing. Even so, with CPI under control, and external pressures dragging on growth, there is little need to move to a more overt tightening posture.

Chinese economic growth

%ytd 14 12 10 8 6 Mar-92 Mar-95 Mar-98 Mar-01 Mar-04 Mar-07 Mar-10 Mar-13
Sources: CEIC, Westpac. * Incremental capital to output ratio: GFCF/GDP / GDP growth rate. A falling ratio indicates greater efficiency, a rising ratio lesser efficiency. In this chart, as the series is inverted, a rising curve is an improvement in efficiency, and vice versa.

ICOR*
Real GDP growth (lhs) Filtered growth rate (lhs) ICOR* (rhs, inverted)

Chinese GDP: real & nominal estimates

25 20 15 %
Deflator %yr Real %yr Nominal %yr Real %saar Westpac Real %saar official

25 20 15

10
5 0
Sources: CEIC, Westpac Economics.

10
5 0

-5 -5 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

4

Chinese GDP: actual versus target

15 13 %
Sources: Westpac Economics, CEIC

15 13

GDP Target

11
9 7

11
9 7

5 5 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

5

Chinese money supply: actual versus target

30 %
Sources: Westpac Economics, CEIC

30

25

M2 money supply Target

25

20

20

15

15

10 10 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

6

Chinese CPI: actual versus target

10 8 %
Sources: Westpac Economics, CEIC

10 8

CPI Target

6
4 2 0

6
4 2 0

-2 -2 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13

7

Aggregate activity proxies

45 %yr
Central revenue Electricity production

%yr
Terrestrial freight

45

M2 money supply

30

30

15

15

0
Sources: CEIC, Westpac

-15 Dec-96

-15 Dec-99 Dec-02 Dec-05 Dec-08 Dec-11

8

Aggregate activity proxies

80 60 40 20 0
Construction starts

%yr
Sources: CEIC, Westpac. Data smoothed.

%yr

40

35
30 25 20 15 10 5 0 Jan-09 Jan-11 Jan-13
9

-20 -40 Jan-01

Imports Real estate investment

Jan-03

Jan-05

Jan-07

Aggregate activity proxies: volume

45 %yr
Cement Steel Electricity

%yr

45

30

30

15

15

0
Sources: CEIC, Westpac. 3mma.

-15 Jan-01

-15 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

10

Central government VAT & IVA

45 %yr
Sources: CEIC, Westpac. 3mma.

%yr

45

30

30

15

15

0
VAT revenues IVA

-15 Jan-97

-15 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12

11

Chinese electricity production

45 %yr/ppt
Contribution from other sources Sources: CEIC, Westpac Contribution from thermal generation

%yr/ppt

45

30

Electricity production

30

15

15

-15 Dec-96

-15 Dec-99 Dec-02 Dec-05 Dec-08 Dec-11

12

Business conditions & real GDP

75
Net balance
Business situation* (lhs) Real GDP growth (rhs) %yr

15

12

65

9
55 6
Sources: CEIC, Westpac Economics. * 5000 enterprise survey.

45 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11

13

Surveyed profits & nominal GDP

25 20 15 10 5
Sources: CEIC, Westpac Economics. * 5000 enterprise survey.

%yr Nominal GDP growth (lhs) Profitability* (lhs)

Net balance

65 60 55 50 45 40

0 Dec-99

Dec-02

Dec-05

Dec-08

Dec-11
14

Industrial profits & central revenues

36 30 %yr
Sources: CEIC, Westpac

%yr

80 60

24 18
12 6 0 Jun-00
Revenue growth (lhs) Profits (rhs, smoothed)

40 20
0 -20 -40 Jun-02 Jun-04 Jun-06 Jun-08 Jun-10 Jun-12
15

Corporate survey: order books and profits

65
60 55

net bal.
Foreign orders Domestic orders Profitability

net bal.

65
60 55

50
45 40
Sources: CEIC, Westpac Economics.

50
45 40 35 Jun-96 Jun-00 Jun-04 Jun-08 Jun-12
16

35 Jun-92

New orders & export orders: PMI measures

65 60
55 50 45 40
NBS new orders* NBS new export orders* Markit-HSBC new export orders Markit-HSBC new orders
Sources: CEIC, Markit *Seasonally adjusted by Westpac Economics.

index

index

65 60
55 50 45 40

35 35 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

17

Urban purchasing intentions: housing & cars

140 130 120 % average
Sources: CEIC, Westpac Economics. All series expressed as a percent of their long run averages.

% average
Plan house purchase (lhs)
Plan auto purchase

140 130 120

110
100 90 80 70 Sep-02 Sep-04 Sep-06 Sep-08 Sep-10 Sep-12

110
100 90 80 70

18

Urban consumer confidence: income

120 %net bal
Sources: CEIC, Westpac Economics. All series expressed as a percent of their long run averages.

120 115 110 105

110

100

100
95

90

Current income confidence Future income confidence

90 85 80 Sep-08 Sep-10 Sep-12

19

80 Sep-02

Sep-04

Sep-06

Consumer saving/investment preferences

140 130 120 110 % long run average
Preference for savings deposits (lhs)

% long run 200 average 175 150 125

Preference for active investment (rhs)

100
90 80 70 60 Mar-01 Mar-03 Mar-05 Mar-07
Sources: CEIC, Westpac Economics. All series expressed as a percent of their long run averages.

100
75 50 25 0 Mar-09 Mar-11 Mar-13
20

Housing and auto sales

150
125 %yr
Auto sales Housing sales

%yr

150
125

100
75 50 25 0 -25

100
75 50 25 0

-50 Jan-01

Sources: CEIC, Westpac Economics. Autos are unit sales. Housing sales are by value.

-25 -50

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Jan-13
21

The housing cycle in fair weather and foul

100 80 60 % April over March
2010 2011

% April over Sources: CEIC, March Westpac Economics

100 80 60

2012

2013

40
20 0 Nationwide Big 3 Other Beijing

40
20 0

22

Chinese housing sales by region

200 Sources: CEIC, Westpac Economics. 175 Centre East 150 West 125 100 75 50 25 0 -25 -50 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15
%yr %yr

200 175 150 125 100 75 50 25 0 -25 -50

23

Chinese construction activity

40
%yr
Sources: CEIC, Westpac Economics.

%yr

40

30

30

20 Raw %yr %yr 3mma %yr 12mma 0 Jan 05

20

10

10

Jul 06

Jan 08

Jul 09

Jan 11

Jul 12

Jan 14
24

Chinese investment: converging trajectories

75
60 45 30 15 0
end 2009 shares of total investment in ( ). Sources: CEIC, Westpac Economics.

%ytd
Transport (12%) Manufacturing (30%) Utilities (7%) Real estate (22%)

%ytd

75
60 45 30 15 0 -15

-15 Jan-04

Jan-06

Jan-08

Jan-10

Jan-12
25

Contributions to Chinese investment growth

30 25

ppt ytd
Sources: CEIC, Westpac Economics

ppt ytd
forecasts

15 10

20 15
10 5 0 -5 Sep-05 Sep-07 Sep-09 Sep-11 Sep-13
Infrastructure (lhs) Real estate (rhs) Heavy industry (rhs)

5 0
-5 -10 -15 -20

26

Contributions to Chinas investment growth

15 12

ppt
Contribution to year-ended growth rate

9 6
3 0 -3
Sources: CEIC, Westpac Economics

Infrastructure Real estate

-6 Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13
27

State owned enterprises & fixed investment

60 50 40 30 20 10 ppt cont
Sources: CEIC, Westpac.
peak share for SOEs (Jan/Feb 2009)

% share of growth
SOE contribution (lhs)

55 50 45

Other contribution (lhs) SOE share of growth (rhs)

Peak SOE share (rhs)

40
35 30 25 20

2005

2006

2007

2008

2009H1 2009H2 2010H1 2010H2 2011H1 2011H2 2012H1 2012H2 Jan-May '13

15

28

Investment projects by approver & by SOEs

50 40 30 %ytd %ytd 50 40 30

SOEs Central government Local government

20
10
value of projects

20
10 0
Sources: CEIC, Westpac Economics.

0 -10 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

-10

29

Real investment growth and its GDP contribution

10 8 6 4 2 ppt cont.
Sources: CEIC, Westpac. * Ratio of growth rates of, respectively, real urban fixed investment and implied real gross capital formation.

ratio
GCF cont. to real GDP growth (lhs) Ratio to partial data* (rhs)

5 4 3 2 1

0
Mar-09 Mar-10 Mar-11 Mar-12 Mar-13

30

Chinese infrastructure spending growth

50 ppt cont.
Other Other transport* Highways Energy Total

40 30 20 10 0 28

42

forecast

22 16

23

26
19

18
6 3

Sources: CEIC, Westpac. Contribution to full year growth. * Railways, airports, mass urban transit, pipeline, waterways.

-10
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
31

Contributions to fixed investment growth

40 ppt cont.
Sources: CEIC, Westpac. Contribution to full year growth.

ppt cont.
Other services & primary Manufacturing Infrastructure Real estate
5.9 3.7 4.9 11.9 13.7 6.9 5.5 1.0 8.2 8.3 3.8 5.8 6.8 7.2 6.0 5.0 4.5

30
4.5 3.8 3.6 4.8

5.2

7.6

3.1 7.7

20

10.1 8.2 9.9 9.1

3.9

10

9.1

7.6

4.4

7.0

5.0

5.3

8.2

5.6

5.4

5.6

0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

32

Major cities: rail network & population density

700

Rail track metres per sqm

London OsakaKobeKyoto Hong Kong

600 500 400

300
Paris

SeoulIncheon

TokyoYokohama Nagoya

Singapore

200 100 0 0 5
New York GZ TJ BJ NJ Shanghai SZ Taipei CQ WH DL

Sources: Westpac Economics, OECD. 2012 figures.

1000 people per sqm

15 20 25 30

10

33

China: existing and planned subways

1200
kms
Planned (lhs) Underway (lhs) Existing (lhs) Eventual city density (rhs)
1 Fosham 2 Wuhan 3 Zhengzhou 4 Guangzhou 5 Fuzhou 6 Shanghai 7 Taiyuan 8 Dongguan 9 Shenyang 10 Nanjing 11 Tianjin 12 Ningbo 13 Xian 14 Shenzhen 15 Nanning 16 Chongqing 17 Wuxi 18 Beijing 19 Harbin

Track metres per sqm

20 Hangzhou 21 Qingdao 22 Nanchang 23 Guiyang 24 Dalian 25 Suzhou 26 Wenzhou 27 Changchun 28 Kunming 29 Lanzhou 30 Hefei 31 Shijiazhuang 32 Xiamen 33 Chengdu 34 Changsha 35 Changzhou Sources: OECD, Westpac.

900 800 700

1000 800 600 400 200 0

1 2 3 4 5 6 7 8

Beijing current density (rhs) Eventual weighted density (rhs)

600
500 400

300
200 100

9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35

34

Monetary and fiscal policy in China

15 10 5 0

Gap ppt
Credit to GDP gap (lhs)
Fiscal position (rhs)

% of GDP
forecast

3 2 1 0

-5
-10 -15
Sources: CEIC, Westpac Economics.

-1
-2 -3 -4 Mar-01 Mar-05 Mar-09 Mar-13
35

-20 Mar-97

Central government finances

36 %yr
Sources: CEIC, Westpac

%GDP

12

24

12
Balance %GDP (rhs) Revenue growth (lhs) Expenditure growth (lhs)

-12 -4 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12
36

Bank credit to GDP gaps: major economies

20 15 ppt
Sources: CEIC, Westpac Economics. Ratio of de-trended loan stock to nominal GDP. l = 400,000.

20 15

10
5 0 -5 -10

10
5 0 -5 -10 China India Mar-02 US Eurozone Mar-05 Mar-08 Mar-11
37

-15
-20 -25 Mar-99

-15
-20 -25

Growth in the monetary aggregates

40 %yr Deposits M1 M2 DXRR* %yr 40

30

30

20

20

10
Sources: CEIC, Westpac. * DXRR: Deposits ex required reserves.

10

0 Dec-99

0 Dec-02 Dec-05 Dec-08 Dec-11

38

Chinese interest rates: market & administered

9 8 7 6 5 %pa
3m SHIBOR 3m PBOC bill PBOC 3m or less FI rate PBOC 1yr FI rate 1 year benchmark lending

%pa

9 8 7 6 5

4
3 2 1
Sources: Westpac Strategy, Bloomberg.

4
3 2 1

0 0 Nov-06 Aug-07 Jun-08 Apr-09 Feb-10 Dec-10 Oct-11 Aug-12 May-13

39

Peoples Bank open market operations

1600 1200 800 400 0 -400 -800 -1200 -1600 Jan-11
Reverse repo maturities Bills issued Reverse repo Net injection/withdrawal Repo Bill maturities Repo maturities
First bill issues since Dec-11.

RMBbn
Sources: CEIC, Westpac

RMBbn RRR cuts

First non-passive withdrawal via repo since June 2012.

1600 1200 800 400 0 -400 -800 -1200 -1600

Net injection

Net withdrawal

May-11 Sep-11

Jan-12 May-12 Sep-12 Jan-13 May-13

40

Peoples Bank bill maturity timeline

180 150
120 90 60 30 0 Dec 09 RMBbn
Maturing bills, all tenors
Sources: CEIC, Westpac

RMBbn
Still to come

180 150
120 90 60 30 0

Jul 10

Feb 11

Aug 11

Mar 12

Dec 12
41

1-yr lending rate & the sanctioned discount

9 %pa %pa 9

8
7 6 5 4
Lowest potential rate under discount regime
Sources: Westpac Strategy, Bloomberg.

8
Benchmark

7 6 5 4 3

3 01/11/06 10/01/08 25/03/09 07/06/10 17/08/11 23/09/12

42

Real deposit and lending rates

8 6 4 2 0 -2
Sources: CEIC, Westpac Economics.

%
Real 1 year lending rate Real 1 year deposit rate

8 6 4 2 0 -2

-4 Mar-01

Mar-03

Mar-05

Mar-07

Mar-09

Mar-11

-4 Mar-13
43

Loans executed relative to benchmark

120 100 80 60 40 20

%
10% above 10% below At benchmark

%
Source: CEIC

120 100 80 60 40 20

0 0 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

44

Credit policy, demand & supply perceptions

150 % LR avg
Banks on 'easyness' of policy (lhs) Bank assessment of loan demand (rhs) Firms on lending attitude of banks (rhs)

% LR avg

125

140
130 120

120
115 110

110
100 90 80 70 60
Sources: Westpac Economics, CEIC.

105
100 95 90 85 80 75 Mar-06 Mar-08 Mar-10 Mar-12
45

50 Mar-04

Policy stance, lending standards & loan rates

35 % of total
Sources: Westpac Economics, CEIC, Shu & Ng 2010. * Loans written at least 10% below the benchmark
Tight Prudent

index

45 42

30
25 20 15

39
Tight

% discounted loans* (lhs)

36 33
Appropriately Loose

10
Lending attitude of banks (rhs)

Sound, Easing bias

Sound, tightening bias

Sound, Appropriately tightening bias Tight

0 Mar-01

30 Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Mar-13

46

Credit policy & supply perceptions

100 % net bal
Banks on 'easyness' of policy (lhs)
Appropriately Tight Tight Prudent

index

45 42

90
80

Firms on lending attitude of banks (rhs)

Tight

70 60 50 40 30 Mar-01
Sound, Sound, Easing bias tightening bias Sound, tightening bias
Sources: Westpac Economics, CEIC, Shu & Ng 2010.

39
36 33 30 Mar-09 Mar-11 Mar-13
47

Appropriately Loose

Mar-03

Mar-05

Mar-07

Credit demand & supply perceptions

108 % LR avg
Bank assessment of loan demand (lhs) Firms on lending attitude of banks (rhs)
Tight

index
Prudent

45 42

104
100 96 92 88 84

39
36
Sources: Westpac Economics, CEIC, Shu & Ng 2010.

Tight

33
Sound, Appropriately tightening bias Tight Appropriately Loose

80 Mar-01

Sound, Sound, Easing bias tightening bias

30 Mar-13
48

Mar-03

Mar-05

Mar-07

Mar-09

Mar-11

Medium & long term loans

140

MLT % of total
New medium and long term loans (rhs) MLT share (lhs)

RMBbn
Sources: CEIC, Westpac. MLT share is smoothed.

1250

120
100 80

1000
750 500 250

60
40 20

0 Jan 04

0
Jan 06 Jan 08 Jan 10 Jan 12
49

Total credit supply new flows

200 175

%yr
TSF (lhs) Banks* (lhs) Other finance (rhs)

%yr
Sources: CEIC, Westpac. * Local currency loans only. 12 month sum of new flows.

640 560

150
125 100 75 50

480
400 320 240 160

25 0
-25

80 0
-80

-50 Jan-04

-160
Jan-06 Jan-08 Jan-10 Jan-12
50

Credit supply growth & loan composition

125 %yr
TSF (lhs)
MLT share of bank loans (rhs)

%yr

175

100
75 50 25 0 -25
Sources: Westpac Economics, CEIC. TSF is total social financing. MLT is medium and long terms loans.

150
125 100 75 50 25 0

-50 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

51

New credit: slowed in May

3000

RMBbn
Sources: Westpac, CEIC.

RMBbn
Other financing* Bank medium & long term Bank - Bill finance Bank to Household Bank short term Total bank

3000

2500
2000 1500

2500
2000 1500

1000
500 0
* Other financing includes trust and entrusted loans, equity and bond raisings, non-bank bills and FX loans.

1000
500 0

-500 Jan 09

-500
Jan 13
52

Jan 10

Jan 11

Jan 12

Chinese total social financing nominal levels

20 RMB trillion
Other Bonds FX loans

% share

50

15

Bill finance Trust and entrusted loans RMB bank loans Non-bank share (rhs)

40

10

30

20

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013f

10

53

Property developer finance: growth by type

125 100 75 %yr
"Self raised"
Loans Down payments and sales revenue Total

%yr

125 100 75

50 25
0 -25 -50 Dec-04
Sources: CEIC, Westpac Economics.

50 25
0 -25 -50 Dec-06 Dec-08 Dec-10 Dec-12
54

Land purchased and construction starts

80
60 40 20 0 Starts (volume) -20 Land purchased -40 Jan-00 -40 -20 %yr
Sources: CEIC, Westpac Economics. 12mma.

%yr

80
60 40 20 0

Jan-02

Jan-04

Jan-06

Jan-08

Jan-10

Jan-12
55

Residential sales & starts: volumes

90 75
60 45 30 15 0 -15 -30
Sources: CEIC, Westpac. Underlying data in sqm. Raw oya growth rate.

%yr

%yr Sales
Starts

90 75
60 45 30 15 0 -15 -30

-45 -45 Jan-99 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
56

Chinese land prices: total & residential

% 6mth 25 annualised
20
Total

% 6mth annualised

25 20 15

15
Residential

10 5
0 -5 -10 Mar-05 Sep-06 Mar-08
Sources: CEIC, Westpac Economics. Land prices are a spliced series for 70 cities up to Dec-10 and 105 cities since.

10 5
0 -5 -10 Sep-09 Mar-11 Sep-12
57

70 city house prices: month-on-month changes

100 80

Net % of cities
Sources: CEIC, Westpac Economics

No. of cities
Number increasing (rhs) Number declining (rhs) Net % Rising (lhs)

70

60
40 20 0 -20

60
50 40

30
20 10

-40 -60
-80

-100 Feb-11

0
Aug-11 Feb-12 Aug-12 Feb-13
58

New supply less of a weight on prices

75 60
45 30 15 0 -15
Sources: CEIC, Westpac. Underlying data in sqm. 12 month average of raw oya growth rate.

%yr

%yr Sales
Completions

75 60
45 30 15 0 -15

-30 -30 Aug-99 Aug-01 Aug-03 Aug-05 Aug-07 Aug-09 Aug-11 Aug-13
59

Commercial & off market construction

90 75 60 45 30 15 0 -15 -30 -45 -60 Jan-05
%yr
Market residential
Market non-res. Non-market res.

%yr

Non-market non-res

Sources: CEIC, Westpac Economics. Data is 3mma of yoy % growth.

90 75 60 45 30 15 0 -15 -30 -45 -60

Jan-07

Jan-09

Jan-11

Jan-13
60

Steel inventory cycle: April 12 to Apr 13

60 45 30 15 0
Apr2013 Aug2012

inventories %yr

Jul2012 May2012 Apr2012 Mar2013

Sep2012
Oct2012

-15
Jan2013

-30 -15 0 15 30 45

Sales %yr

60
61

Daily iron ore prices in China

USD/t 190
Sources: Westpac Economics, Bloomberg, SGX Asiaclear

USD/t 190
+82% in 3 months

175
160 145 130 115
30% in two months

175
160 145 130 115

100
85

70 Aug-10 Dec-10 May-11 Sep-11 Feb-12 Jul-12 Nov-12 Apr-13

3 mth forward 9 mth forward TSI 62% fines benchmark

36% in two months

30% in five months

100
85

70

62

Chinese imports total & key raw materials

600
500 400 index
Sources: CEIC, Westpac Economics. Value of total imports and volume of raw materials.

index

600
500 400

Total imports
Crude oil Iron ore

300
200 100

300
200 100

0 Jan-01

0
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

63

Shanghai-London copper spread

12 10 8 15 6 10 4
London expensive
SHFS copper (lhs) SHFS % premium over LME (rhs smoothed)

US$'000 t
Shanghai expensive
17% Chinese VAT premium over LME

30 25

20

5
Sources: Westpac Economics, Bloomberg

2 Jan-06

0
Jan-12
64

Jan-08

Jan-10

Various measures of inflation

15 10
5 0
Non-food CPI Fixed investment price index

%yr
Sources: CEIC, Westpac Economics.

%yr

15 10
5 0

May prints for CPI and PPI

-5 -10 Mar-04

Consumer price index GDP implicit price deflator Producer price index

-5 -10

Sep-05

Mar-07

Sep-08

Mar-10

Sep-11

Mar-13
65

Chinese consumer prices

25 20 15 %yr Total Shelter Clothing Food Health

%yr

25 20 15

10
5 0 -5

10
5 0 -5

Sources: CEIC, Westpac Economics.

-10 Jan-01

-10
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
66

Chinese CPI: the shelter component

15 10 5 %yr
Sources: CEIC, Westpac Economics.

%yr

15 10 5

0
-5 -10 -15 Total Building costs Rent Private housing Utilities Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

0
-5 -10 -15

-20 Jan-01

-20

67

Chinese producer prices

40 30 20 %yr
Sources: CEIC, Westpac Economics.

%yr

40 30 20

10
0 -10 -20 Total Producer goods Mining Raw materials Manufactured Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

10
0 -10 -20

-30 Jan-01

-30

Decomposing 12 month real CNY appreciation

20

ppt
Relative price level Nominal exchange rate Real exchange rate USD/CNY inverted

ppt

20

16
12 8 4 0 -4 -8

16
12 8 4 0 -4 -8

Source: BIS, Westpac.

-12 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

-12

69

Chinas exchange rate: broad & bilateral USD

140 130 120 index
Sources: CEIC, BIS. Indices = 100 in July 2005.

index

140 130 120

110 100
90
Real Nominal USD per Yuan

110 100
90 80 70 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09 Jan-12
70

80 70 Jan-94

Food prices & the exchange rate

25
20 15 %
Food price inflation %yr (lhs) USD/CNY %yr (rhs)

10
8

forecast

10
5 0
Sources: Westpac Economics, CEIC.

4
2 0

-5 -2 Jan-01 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15

71

The exchange rate & inflation

30 Sources: CEIC, Westpac Economics 25 20 15 10 5 0 -5 -10 -15 -20 Jan-01 Dec-03 Nov-06

%chg

%chg

Annualised CPI inflation (lhs) Annualised CNY appreciation (rhs)

30 25 20 15 10 5 0 -5 -10 -15 -20

Oct-09

Sep-12
72

Exporter margins and the exchange rate

% 10
Range of profit margins in key export industries

10
Annual appreciation of CNY

8 6

8 6

4
2 0
Sources: Westpac Economics, CEIC,

4
2 0

-2 Jan-01

-2
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
73

FX reserves, capital flows & bank FX positions

120 100 80 60 40 20 0 -20 -40 -60 -80 -100 Jan-10
USDbn USDbn
Sources: CEIC, Westpac

Other FDI inflow Trade balance Change in FX reserves Net bank FX settlement

120 100 80 60 40 20 0 -20 -40 -60 -80 -100

Jul-10

Jan-11

Jul-11

Jan-12

Jul-12

Jan-13
74

Foreign exchange loan to deposit ratio

800 700 600
500 400 300 200 100 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13
75

USDbn
FX Ratio L2D (rhs) Deposits (lhs) Loans (lhs)
FX L2D adjusted for policy banks
Sources: CEIC, Westpac

Ratio*100

225
200 175 150 125 100 75 50 25 0

Onshore L2D ratio

USD/CNY NDF pricing

8.4 8.2 8.0 7.8 7.6 7.4 7.2 7.0 6.8 6.6 6.4 6.2 6.0 CNY CNY 8.4 8.2 8.0 7.8 7.6 7.4 7.2 7.0 6.8 6.6 6.4 6.2 6.0

3mth 6mth 12mth 1mth

Sources: Westpac, CEIC

Feb 03

Jan 05

Jan 07

Jan 09

Dec 10

Dec 12

76

USD/CNY NDF curves

40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70 bps 12mth minus 3mth 12mth minus 6mth 12mth minus 1mth bps 40 30 20 10 0 -10 -20 -30 -40 -50 -60 -70

Sources: Westpac, CEIC

Feb 03 Mar 04 Apr 05 May 06 Jun 07 Jul 08 Aug 09 Oct 10 Nov 11 Dec 12

77

USD/CNY NDF curves

10 5 0 -5 -10 -15 -20
Sources: Westpac, Bloomberg

bps
12mth minus 3mth 12mth minus 6mth 12mth minus 1mth

bps

10 5 0 -5 -10 -15 -20

-25
Jan 10 Jun 10 Dec 10 Jun 11 Dec 11 Jun 12 Dec 12 Jun 13

-25

78

Projecting FX turnover: some considerations

World international assets in total world assets

RMB invoicing in Chinese trade

Chinese international assets in total Chinese assets

RMB share of Chinese IIP stock and flow

Pace of pertinent reforms

Chinese trade in world trade

Source: Westpac Economics

Growth of global FX turnover

World trade in world GDP

Chinese GDP in world GDP

RMB share of third party transactions

79 79

Growth spillovers between systemic economies

0.25

0.20 p e r c e n t

0.15

0.10

0.05 0.00 China

Euro area
Impulse response from positive 1ppt output shocks. Source: IMF

US Japan From Euro area From China From Japan From US

80

Net IIP in the G20: many debtors, few creditors

50 40 30 20 10 0

%GDP

%GDP
Source: IMF, Westpac.

50 40 30 20 10 0

-10
-20 -30 -40 -50
JPY DEU CNY ARP RUB INR KRW FRA CAD GBP ZAR USD BRL ITA IDR MXN TKL AUD

-10
-20 -30 -40 -50

81

Various measures of Chinese export leverage

40
%GDP
Net exports %GDP Export GVA %GDP Gross exports %GDP
Sources: CEIC, Westpac.

%GDP

40

30

30

20

20

10

10

0
2000 2002 2004 2006 2008 2010 2012

82

Value added from exports & domestic demand

15.0
12.0 9.0 6.0 3.0 0.0
ppt
Sources: CEIC, Westpac.

-3.0
2000 2002 2004 2006 2008 2010 2012 2014

83

World export shares by country & region

15
12
Other Asia

% world total
USA
Sources: WDI, Westpac. Goods & services.

9
Japan

Germany

6
UK

France

China

3
India

0
1984 1988 1992 1996 2000 2004 2008

84

Manufacturing exports and resource imports

25
20 15 10 5
% world total
Japan - manuf exports China & HK - manuf exports Germany - manuf exports USA - manuf exports Japan - resource imports China & HK - resource imports Germany - resource imports USA - resource imports

Sources: WDI, WTO. Resource imports defined as fuel & mining products.

0 1980

1985

1990

1995

2000

2005

2010

85

Nominal export shares: major countries

60
50 40 30 20 10
% GDP
Sources: CEIC, OECD, Westpac, Dragonomics. Ex China, nominal national accounts basis for goods and services. For China, goods only, value-added estimates.

0
AUD FRA DEU JPY KRW SEK TKL GBP USD BRL INR CNY

86

Chinas share: selected elements of world activity

25 20 %
Sources: UN, IMF, IEA, Westpac Economics. * Goods & services. ^ Total primary energy supply `` From fossil fuel combustion. All national accounts related shares are in 2005 constant US dollars.

1980

2000

2010

15
10 5 0

Manufacturing value added

Household consumption

Gross fixed capital formation

Construction value added

CO2 emissions``

Services value added

Nominal USD GDP

Energy use^

Exports*

Imports*

PPP GDP

87

Chinese exports to developed markets

75 60 %yr
Sources: Westpac, CEIC. 3mma.

%yr

75 60

45 30 15 0 -15
-30 -45
Jan-2001 Jan-2004 Jan-2007 Jan-2010 Jan-2013

45 30 15 0
US Korea Japan Europe Australia

-15
-30 -45

88

Chinese exports to developed markets

75 60 %yr
Sources: Westpac, CEIC. 3mma.

%yr

75 60

45 30 15 0 -15
-30 -45
Jan-2001

45 30 15 0
US Australia Canada
Jan-2004

Japan New Zealand EU

Jan-2007 Jan-2010 Jan-2013

-15
-30 -45

89

Exports to emerging markets

120 100 80 60 40 20 0 -20 -40 -60
Jan-2001 Jan-2004 Jan-2007 Jan-2010 Jan-2013

%yr
Sources: Westpac, CEIC. 3mma.

%yr

120 100 80 60 40 20 0 -20 -40 -60

India Taiwan Brazil

Korea Russia ASEAN

90

Chinese imports from developed markets

90 75 60 45 30 15 0 -15 -30 -45
US NZ Japan Canada Australia EU

%yr
Sources: Westpac, CEIC. 3mma.

%yr

90 75 60 45 30 15 0 -15 -30 -45

Jan-2001

Jan-2004

Jan-2007

Jan-2010

Jan-2013

91

Imports from emerging markets

180 150 %yr India Taiwan Brazil Korea Russia ASEAN %yr 180 150

120 90 60 30 0
-30 -60
Jan-2001 Jan-2004
Sources: Westpac, CEIC. 3mma.

120 90 60 30 0
-30 -60

Jan-2007

Jan-2010

Jan-2013

92

Chinese trade: uneven outcomes

90 75 60 45 30 15 0 -15 -30 -45
Jan-2001 Jan-2004 Jan-2007 Jan-2010 Jan-2013

%yr
Exports to US/EU/JP Sources: Westpac, CEIC. 3mma. Imports from commodity producers Imports from NIEs Exports to NIEs Imports from US/EU/JP

%yr

90 75 60 45 30 15 0 -15 -30 -45

93

Contributions to Chinese customs exports

60 45 30 15 0 -15 Rest of world Taiwan HK Total

% points
Sources: CEIC, Westpac Economics. Contributions to yoy growth rate.

% points
HK & Twn cont. fell 8ppts In May. ROW cont. fell 6ppts.

60 45 30 15 0 -15

-30 Dec-94 Dec-97 Dec-00 Dec-03 Dec-06 Dec-09 Dec-12

-30

94

Mainland-HK trade discrepancy

80 60 40 %yr
Sources: Westpac, CEIC. 3mma.

%yr

80 60 40

20
0 HK customs -20 -40
Jan-2001 Jan-2004 Jan-2007 Jan-2010 Jan-2013

20
0 Chinese customs -20 -40

95

Chinas current account balance

12

% GDP
Change in reserves Other CA Trade Current account

% GDP

12

9
6 3 0

9
6 3 0

-3 Dec-98

-3
Dec-01 Dec-04 Dec-07 Dec-10
96

Chinas balance of payments

% GDP 12 9 6 3 0 -3 -6 -9 Change in reserves Other (incl errors & omissions) -12 Portfolio balance -15 Direct balance -18 Current account -21 Dec-98 Dec-01 Dec-04 % GDP
12 9 6 3 0 -3 -6 -9 -12 -15 -18 -21

Dec-07

Dec-10
97

The state of global imbalances

3 2 1 0 -1 -2 -3 1994 1998 2002 2006 2010 2014 2018
98

% WGDP
South Asia MENA, Canada and Russia CEE and CIS ex Russia Other EU China NIEs & ASEAN 5 Latam Germany Japan USA

% WGDP
Sources: IMF, Westpac.

Chinas trade balance decomposed

15 % GDP
Overall trade balance Primary products balance

% GDP

15

10
5

Total manufacturing balance machinery and transport balance (lhs)

10
5

-5
Current USD prices converted to RMB. Sources: CEIC, Westpac Economics.

-5

-10 1980

-10 1985 1990 1995 2000 2005 2010

99

Industrial profits: level & as a share of GDP

9 Ln index
Profits - log level

% GDP

12
11 10 9 8

Profits % GDP

7
6
Sources: CEIC. Underlying data seasonally adjusted by Westpac Economics. Log level is in the quarter. % of GDP is 4qtr sum.

5 4

5 Nov-00

Nov-03

Nov-06

Nov-09

3 Nov-12
100

Income inequality: Chinas path

50 45 40 35 30
Measures the degree to which income distribution deviates from perfect equality. Higher readings are less equal.

Gini index
Sources: World Bank, Westpac Economics.

Gini index
Dont mention the war

50 45 40 35 30

25
20 1980 1985 1990 1995

25
20

2000

2005

2010
101

Income level per capita & its distribution

70

Gini index

South Africa
Colombia China Brazil Chile

Sources: Westpac Economics, WDI

60

50

Mexico Russia
US

40

Thai

30

Poland INR & IDR Malaysia

20
Wealthy OECD

PPP GDP per head

20
0 10 30 40 50 60

102

China: the key messages reiterated

The recovery has been consistently challenged in the year to date by stop-start investment spending, an end to the inventory rebuilding phase and soft external demand, which took a material turn for the worse in May. The majority of the data flow has underwhelmed through March, April and May. The exceptions from earlier in the year - exports (over-invoicing), housing sales (a flurry ahead of tightening), new credit (likewise, plus heavy refinancing), railways (as expected) and manufacturing investment (curious) all levelled out or decelerated in May. Non-food consumer inflation remains relatively low and stable, while producer prices are softening anew. Policy is a heavy influence on many areas of the economy at present: SAFE and CBRC controls are driving tight interbank liquidity and a swift unwinding of disguised capital inflow, which in turn distorts the FX market; housing controls are slowing turnover; and credit data are showing signs of easing from the pace seen in Q1.

Phat Dragon maintains his basic views that

a) A low ceiling recovery-expansion remains in place, leaving one feeling a bit hollow. b) Growth, such as it is, is likely to plateau quite soon, consistent with the degree of policy accommodation having levelled off since late last year. c) The clear intent of the authorities to limit the upside has prevented a more durable upswing. Even so, with CPI under control, and external pressures dragging on growth, there is little need to move to a more overt tightening posture.

103

Westpac Institutional Bank is a division of Westpac Banking Corporation ABN 33 007 457 141. Information current as at date above. This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Westpacs financial services guide can be obtained by calling 132 032, visiting www.westpac.com.au or visiting any Westpac Branch. The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Westpac Banking Corporation is registered in England as a branch (branch number BR000106) and is authorised and regulated by The Financial Services Authority. Westpac Europe Limited is a company registered in England (number 05660023) and is authorised and regulated by The Financial Services Authority. If you wish to be removed from our e-mail, fax or mailing list please send an e-mail to economics@westpac.com.au or fax us on +61 2 8254 6934 or write to Westpac Economics at Level 2, 275 Kent Street, Sydney NSW 2000. Please state your full name, telephone/fax number and company details on all correspondence. 2010 Westpac Banking Corporation. Past performance is not a reliable indicator of future performance. The forecasts given in this document are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.

104