[20081114]UBS China Question of the Week - Why Is IP Growth Falling Sharply? industrial, developed, happening, suddenly, activity

yangruoxin

October industrial value added grew by only 8.2% y/y, the slowest pace
since mid 2001 and far below market consensus. Why is China's industrial
production decelerating so suddenly?
 
Our Answer
- Given what has been happening in global financial market and the
sudden drop in economic activity in developed economies, it has been
suggested that China has been hit hard by this financial crisis.
Actually, data suggest that it is China's domestic demand that is
weakening much quicker than its exports and [the domestic weakness] has
led to the slowdown in IP growth. Export-related slowdown is still in
the pipeline. 
- What led the decline in the growth of industrial production has been
the drop in iron and steel production (Chart 1), which saw a sharper
decline in production than the previous slump of 1997/98. The slowdown
in energy-intensive sectors such as iron and steel has also led to a
steep deceleration in the power sector. This has caused many who assume
a fixed relationship between electricity consumption and GDP growth to
question the accuracy of overall growth data, while we think the uneven
slowdown in the economy has suddenly reduced the energy intensiveness of
growth.
- The weakness in housing related construction activity is by far the
most important driver for decelerating domestic demand, especially that
for steel, cement, consumer durables, and other related products (Chart
2). With housing sales and new constructions now declining, we see a
further drop in domestic consumption of steel and related products and,
therefore, more downside in production in these industries. An unusually
high accumulation of inventories in some sectors (iron and steel again)
has exacerbated the downward adjustment in production.
- The latest trade data also corroborate the view that exports are
holding up better than domestic demand, despite a global downturn. While
real export growth continues to grind down, real import growth collapsed
in October (Chart 3) and, together with a sharp fall in import prices,
this resulted in the largest monthly trade surplus in China's history -
$35.2 billion.
- Looking forward, however, export growth looks set to decelerate
sharply, and we can already detect this trend from both the weak
electronics production (Chart 1) and sharply falling export orders
(Chart 4). Actually, domestic new orders and export orders are both
falling in tandem, which does not bode well for industrial production in
the coming months. Even though the government's fiscal and monetary
stimulus could start to kick in as early as Q4 2008, the downward
pressures from weakening domestic and external demand will likely
dominate in the near term, leading to slower IP growth in the coming
month.
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