Priya Anand Hot Photo in yellow dress

China: Overheating remains the main risk
* The economic data for May released today suggest that so far there has been no major impact from either the European debt crisis or the Chinese government’s recent tightening measures. Based on today’s data GDP growth will remain double-digit in the current quarter and only moderate slightly from around 12% q/q AR in Q1 10. In addition, inflationary pressure is increasing and inflation is poised to exceed 3½% in Q3.
* However, there are signs that the government’s tightening measures will gradually have an impact. Property sales dropped substantially and property prices eased in May and real estate investment should start to slow. With soaring exports, bigger trade balance surplus and increasing inflationary pressure a Chinese revaluation is still on the cards, although it is dependent on some calm returning to financial markets.

Details
Although industrial production in May was slightly weaker than expected the overall picture remains strong. Industrial production in May increased 16.5% y/y (Consensus: 17% y/y) and according to our own seasonal adjusted figures is up a solid 4.2% 3M/3M (see chart). So far industrial production does not indicate any significant slowdown in GDP growth in Q2 relative to the 12% quarter-on-quarter AR GDP growth in Q1. However, we still expect industrial production and GDP to moderate in H2 10, as currently suggested by manufacturing PMI.

Domestic demand continues to look strong. Fixed asset investment improved further in May despite substantial slower credit growth and the government’s recent tightening measures targeting the real estate market (see charts on next page). However, property sales dropped substantially in May and hence we should start to see an impact on real estate investments in the coming months. Retail sales remained strong in May with growth exceeding 2% monthon- month for the second month in a row. Finally data released yesterday showed that China’s export and trade surplus surged in May, see Flash Comment - China: Export and trade surplus surge in May

Consumer prices in May increased 3.1% y/y (Consensus: 3% y/y) from 2.8% y/y in April. Inflationary pressure is increasing but it is not yet out of control. Producer price inflation has eased markedly in recent months on the back of lower commodity prices (see chart) and property prices appear to have peaked. Nonetheless, inflation should continue to increase and could be close to 4% by the end of the year. Hence, there is increasing risk that inflation for 2010 as whole will exceed the government’s target.