First CPI Decline in China since 2002

Newly released data indicate that retail and wholesale prices both declined in China, stoking fears that deflation might return. February consumer price index (CPI) fell year over year for the first time in six years, down by 1.6%, compared with a 1% increase in January. The decline was partly attributable to a higher-than-usual comparison base of last February, when an unprecedented snowstorm led to spiking food prices and sent the CPI up to a 12-year high of 8.7%. Meanwhile, producer price index (PPI) remained on the downward slope, declining by 4.5% in February, compared with a 3.3% drop in January.

As if that is not bad enough, news of a 26% export decline in February also came out in the past week. The fourth consecutive month of year-over-year declines, February saw a sharper drop compared with January, when exports fell by 17.5%. Since imports remained stable, February's trade surplus shrank to $4.8 billion, compared with an average of $40 billion in the past several months. Although Chinese exporters are clamoring for currency devaluation to help boost exports, we think the Chinese government is unlikely to budge to such demand, because it knows any such actions will likely touch off a round of devaluation from its export-oriented neighbors, which in the end would benefit nobody. We believe the government may raise the tax rebates to help exporters, but only moderately, to avoid retaliation from China's trade partners.

Market Recap
Sharp export decline in February and deflationary concern following the new CPI and PPI numbers sent the stocks tumbling in the past week. The Shanghai Composite Index declined by 2.9% to 2,129, while the Shenzhen Composite Index dropped 4.5% to 7,876.

Technology
China Mobile Cut Growth Expectations for TD-SCDMA (3G) Users
China's largest mobile operator has cut its TD user forecast in half for 2009 through 2010 to 50 million, down from the prior target of 100 million. So far, only 20,000 users have signed up for the service.  China Mobile  blamed the sluggish demand on the shortage of handset models.

Industrial
February Iron Ore Import Rose by 22% from January
Chinese steelmakers imported a record 46.8 million tons in February, up by 8.6 million tons from January. Market observers are concerned that some imports are going to small and medium-size steelmakers that are reopening their factories in the anticipation of a demand recovery in 2009. This may further aggravate the overcapacity problem in the industry.

Contributions from Lun Lu, Iris Tan, and Peter Liu.