China to Tighten Further as Inflation Remains Elevated

China's macroeconomic report revealed a robust economic environment despite government tightening. GDP expanded +9.7% y/y in 1Q11 while CPI jumped to +5.4%, the highest level in 32 months, in March. Asian stock markets declined after the report as investors worried that the government will accelerate tightening measures as inflation remains elevated. While we believe we should be cautious towards further tightening, we should not view it too pessimistically. Indeed, Premier Wen Jiao Bao warned earlier in the week about over-tightening while raising the tone on inflation fighting.

 

1Q11 GDP growth was at +9.7% y/y, easing from +9.8% in 4Q10 but higher than consensus of +9.4%. The national bureau of Statistics unveiled for the first time GDP growth data on q/q basis. GDP expanded +2.1% q/q in 1Q11, or an annualized +8.6%. Headline CPI rose to +5.4% y/y in 1Q11, higher than +4.9% in 4Q10 and market expectation of +5.2%.. Undoubtedly, food costs contributed to most of the price rises. Food inflation increased to +11.7% y/y in March from 10.7% in January and February, while non-food inflation climbed to +2.7% y/y from +2.4% in January and February. On monthly basis, inflation dropped -0.2% in March. Indeed, CPI usually fell after CNY holiday but the decline this time was weaker than previous year, thus triggering the government to raise its tone on combating inflation.

 

On Wednesday, Premier Wen Jiabao stated at the State Council's meeting that there have been many complexities and uncertainties in the world economy. He also stressed that maintaining price stability is the top and most pressing task for macroeconomic regulation this year. According to the Premier, inflation pressures remain elevated as driven by rising oil prices due to tensions in the MENA region prices, weakness in USD and structural increases in food and rental costs.

 

We expect the government will continue tightening later this year. While rate hikes and increases in RRR will be adopted, the government may intervene the pricing of food prices. The government may maintain the current M2 growth target at 16% and existing new loan target of RMB 7-7.5 trillion per year.