Chart Of The Week   September 27 2022

Deflationary Forces Weigh On Chinese Industrial Profits

Chinese Profits

Chinese industrial profit growth contracted for the second consecutive month on a year-to-date year-on-year basis in August, falling 2.1% y/y in the first eight months of the year.

The deterioration is broad-based across industries. However, the weakness is significantly more pronounced among downstream sectors versus upstream industries. Profits of manufacturers contracted by 13.4% ytd y/y while those of mining & quarrying companies eased from 105.3% ytd y/y in July to 88.1% in August.

The weaker profit dynamics reflect the sharp slowdown in PPI inflation this year which offset the increase in industrial production over the past few months. Producer price growth has steadily eased from 9.1% in January to 2.3% y/y in August. The bottom line is that weak domestic demand is limiting Chinese firms’ ability to pass on higher prices.

These dynamics ultimately underscore that deflationary forces beset the Chinese economy. The struggling property market and zero-Covid policy are weighing down on private sector sentiment and limiting the effectiveness of stimulus measures.

Policymakers will ultimately continue to ease domestic policy to reflate the economy and the PBoC will probably cut rates further. The implication is that the CNY – which has already depreciated by 11% so far this year – is likely to continue weakening. Moreover, our China Investment strategists recommend onshore asset allocators favor government bonds over stocks.