Phat dragon

28 September 2011

a weekly chronicle of the Chinese economy

Industrial profits expanded 28.2% in the year to August. Phat

Dragon estimates that the seasonally adjusted change in the quarter centred on the month of August was a 2.5% decline. That follows a 7.7% decline in the quarter centred on May. On the revenue side the equivalent rates are 2.8% and 3.3% respectively. The year-ended pace for both profits and revenues still managed to rise a little though, with the 2010 mid-year soft patch representing a flattering base for comparison. Aggregate industrial margins narrowed modestly, but they remain healthy enough overall. So while the industrial sector has undoubtedly entered into a more challenging period for profitability, in an absolute sense the profit upswing of the last two years remains an extremely supportive backstop for activity. Phat Dragon notes that internal funds rose to a 62% share of fixed investment financing as of August, with the share of loans and budgetary financing dropping to just over 20%, which is the lowest proportion ever. So as a group Chinas industrial firms have never been more reliant on their own resources to finance expansion. At the same time, this particular measure of profits, which excludes services and small business, is at its highest level ever as a share of GDP. So while the tightening of credit availability is no doubt partially responsible for the shift in financing shares, the strength of earnings growth has allowed corporate China to absorb this shock and continue investing apace by switching to lower LVRs/higher equity shares in their projects. Any credible proponent of the soft landing view ought to be giving major prominence to the profit story.
9

Industrial profits: level & as a share of GDP

Ln index Profits - log level 8 Profits % GDP % GDP 12 11 10 9 7 8 7 6 6
Sources: CEIC. Underlying data seasonally adjusted by Westpac Economics. Log level is in the quarter. % of GDP is 4qtr sum.

5 4 3

5 Nov-00

Nov-03

Nov-06

Nov-09

Airports and passenger cars

140 120
France
Cars per 1000 persons

Germany

Australia Canada

Sources: Westpac Economics, CIA, WDI. All percent of US level.

100 80 60 40 20 0 0

UK Japan China & India Malaysia Mexico Thailand Indonesia Brazil Argentina

US

Boeing has released new forecasts for Chinese aircraft demand out
to 2020, revising their estimate of a year ago up by a full quarter. Phat Dragon is moved to ask whether or not they imported a boffin from the NDRC to produce the prior estimate: that sort of forecast error (in the direction of under-estimation of course) is de rigeur inside the planning apparatus. On a more serious note, Boeing is sticking to their view that the bulk of demand will come in the small to medium sized segment: a position not shared by Airbus, who believe the transcontinental mega-carrier will be where the volume is. This is fundamentally a debate about what kind of economy China is going to become and how it will balance internal matters and global engagement: Phat Dragons money is on an integrated continental powerhouse with a thriving middle class. At the other end of the spectrum, some persist in projecting China to become a sclerotic entity where the elite channels rents to itself at the expense of the masses, leaving it to suffer from the middle income trap once its global export market share saturates. Each of these starkly different visions of the future dates to beyond 2020 of course. Neither aero-giant will have much cause for complaint from their China business in the coming decade. The US has a little over 15,000 airports, a population of a little over 300 million people, a tightly integrated continental economy and a land area of 9.8 million square kilometres. China also has a land area of 9.8 million square kilometres, a population over 1.3 billion, a very loosely integrated continental economy and a little less than 500 airports. It is an auspicious time to be selling the miracle of flight.

Airports per 1 million persons

20

40

60

80

100

120

140

Iron ore: 3 month forwards betray unease

USD/t 200 190 Sources: Westpac Bloomberg, 180 SGX Asiaclear. 170 160 150 140 130 120 110 100 90 80 Oct-09 Feb-10 USD/t 200 190 180 170 160 150 140 130 120 110 100 90 80

TSI 62% fines benchmark 3 mth forward 9 mth forward

Jul-10

Nov-10

Apr-11

Sep-11

falls in the Australian dollar and Brazilian real have more than covered the US dollar spot decline. Even so, to Phat Dragons eye a cyclical correction in the ferrous metals sphere appears to be underway and price expectations should be ratcheting downwards.

The iron ore market is beginning to exhibit some signs of modest

unease, with 3mth forwards giving up significant ground while spot has moved about 5% lower. From an export profitability perspective,
Westpac Institutional Banking Group Economic Research

Stats of the week: The share of SUVs in Chinese car sales has
increased from 4.5% in August 2006 to 12% in August 2011.
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