• GDP growth accelerated sharply and far exceeded potential driven by very strong domestic demand. Private investment demand has picked up substantially in recent months, reducing the likelihood of renewed weakness when the impact from fiscal easing starts to wane.
  • We have raised our forecast for 2009 GDP growth from 7.9% to 8.5%. The People’s Bank of China should gradually start to rebalance monetary policy to avoid excesses.

Details

The Chinese economy gained considerable momentum in Q2 and at the moment it appears that the Chinese stimulative efforts has been very successful. China only publishes its GDP figure as a year-on-year growth rate and just looking at the year-onyear growth rate masks the underlying strength of the Chinese economy in Q2. According to our own calculations, GDP soared by about 16% q/q AR in Q2 and accelerated sharply compared with Q1, when we estimate that GDP growth was 6.5% q/q AR. Hence, GDP growth has been substantially above potential in Q2.

The current strong momentum in the Chinese economy was confirmed by a stronger-thanexpected increase in industrial production in June. Industrial production has surged by about 25% q/q AR in Q2.

Growth in China is driven mainly by very strong domestic demand. In particular, investment demand looks extraordinarily strong. Part of the explanation is the sharp increase in government investments in connection with the government’s stimulus package. As seen on the first chart on the next page, government investments were the sole driver behind the increase in investments in late 2008 and early 2009. However, this is no longer the case. Private investments including real estate investments have accelerated sharply in recent months, while growth in government investments has started to ease slightly. This suggests we are unlikely to see a sharp slowdown in growth when the impact from fiscal easing starts to wane.

Consumer price inflation in June declined more than expected to -1.7% y/y from -1.4% y/y in the previous month. However, in our opinion, deflation is currently not really a major threat in China. The decline in inflation is mainly due to base impact from higher food and energy prices last year. Month-on-month consumer prices have already stopped declining and over the past three months CPI is up 1.9% 3m/3m AR (see chart on next page).

Assessment and outlook

We now expect GDP to be in the double digits in H2 09. We have raised our forecast for GDP growth in 2009 from 7.9% to 8.5%. We have adjusted our 2010 forecast marginally upwards from 9.5% to 9.6%. There will be a need to rebalance monetary policy. The People’s Bank of China has already started soaking up liquidity in the interbank market by selling treasuries and bond yields have increased sharply in recent months. The reintroduction of some lending control later this year cannot be ruled out. We still believe the gradual appreciation of CNY will be resumed next year.