Wednesday, September 12, 2007

China: Infrastructure investment hits mid-cycle slowdown

The PMI index, up mildly to 54 in August, still points in the direction of a moderation in economic activity in the coming months. This is consistent with our call that GDP growth will soften towards 10.5% in H207, synchronizing to a global slowdown led by the US. Executives complained more about rising food prices and wage rates than commodity prices lately.
The most important message from the survey is the continued weakness in machinery orders. New orders for general machinery, electric machinery and transportation equipment remained subdued. We think a mid-cyclical slowdown in infrastructure investment is happening now, possibly affecting domestic and international machinery producers.
We think the moderation in new loan issuance is probably responsible for the slide. The pace of infrastructure investments in railway, airport and power stations has slowed anecdotally, but this is unlikely to be the end of China's infrastructure boom.
We argue that the real economy is not as overheated as others suggested, and Beijing probably would only launch selective and measured tightening to the real economy. However, inflation remains out of control and interest rates need to rise substantially, in our view. Rate hikes will likely keep up with inflation and maintain a neutral monetary policy stance.