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China's Official PMI Dispels Doubts on the Economy's Strength

04-01 16:29 Caijing
We maintain our forecast that China's economy will grow 9% this year, supported by solid domestic demand and improving external conditions.

•  The headline index surged to 53.1 in March, much stronger than market expectations, compared with February's 51.0. The improvement was across the board. 
•  The production index rose strongly to 55.2 from 53.8 previously.  
•  The new export orders index improved marginally by 0.8pts to 51.9; the new order index jumped 4.1 pts to 55.1. 
•  Input prices gained for the fourth straight month in March, up by 1.9pts to 55.9, largely due to a recent hike in retail fuel prices. Slowly rising input prices also creates an upside risk to China's PPI in the following months. 


Today's PMI suggests that China's manufacturing sector continues to expand, consistent with our view that the economy's momentum is strengthening. With the recent rises in electricity output we expect heavy industry production to have bounced back in March, consistent with its cyclical pattern and the end of a colder-than-usual winter this year. 
Meanwhile in Q1, falling inflation together with a weak RMB have helped maintain China's export competitiveness. Rising consumption growth in the US and the stabilising euro debt crisis have helped to shore up confidence amongst export-oriented firms.

As a result, the export sector is less likely to be a drag on the economy's overall performance.

Based on today's PMI reading, we continue to expect cautious, though supportive, monetary policy easing. Also, market liquidity conditions will remain accommodative as a large amount of PBoC bills fall due in April and May. As long as the PBoC maintains the level of intensity in its open market operations in Q1, we expect banking sector liquidity will continue to improve. This in turn will allow banks to lend more. A cut in banks' reserve requirement ratio (RRR) could then occur when the impact of matured PBoC bills diminishes and market liquidity conditions tighten. Of course, trade surplus and capital inflow data will also influence the decision to cut. 
Balancing these factors, we believe a RRR cut could be delayed further to May or June, and we maintain our view that an interest rate cut at this stage is not possible as the real interest rate remains close to zero and inflationary pressures are rising.
Though the real economic activity momentum has picked up steadily since Nov 2010, growth has slowed on a year-on-year basis. We thus expect China's economy will grow 8.6% in Q1 and pick up further in the following quarters. 
We maintain our forecast that China's economy will grow 9% this year, supported by solid domestic demand and improving external conditions. 

Contributors: LI-GANG LIU, HAO ZHOU


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