Should We Worry about Deflation in China?

China's consumer price index fell 1.5% year over year in April, the third consecutive decline since February. The decline was partly attributed to a drop in food prices--more specifically, in pork prices--as the swine flu outbreak slowed down pork consumption in China (although there is little scientific evidence to link the two). For the first four months of 2009, CPI fell by 0.8% from the same period last year. Meanwhile, the producer price index, which tracks prices at the wholesale level, was down by 6.6% year over year in April, compared with a 6% decline in March. For the January-April period in 2009, the index fell by 5.1% compared with last year.

Although both pricing indexes have been on the decline this year, we think the likelihood of deflation looks low at this point, given ample liquidity and fast-growing fixed asset investment due to the government's stimulus plan. By the end of April, Chinese banks collectively made new loans of more than CNY 5 trillion, exceeding the previously set lending quota for 2009. The pace of loan growth has slowed down in April, as the government grew wary of potential bubbles if the capital flows into the stock and real estate markets for speculation. The surge in bank lending has led to a 31% year-over-year increase in urban fixed-asset investments in the first quarter of 2009, at a total of nearly CNY 4 trillion.

Market Recap
The Chinese stock markets were flat this week, as investors tried to digest the economic trends after the release of key economic statistics. The Shanghai Composite Index rose by 0.7% to 2,645 from 2,626. Similarly, the Shenzhen Composite Index rose by 0.9% to 10,273 from 10,183.

Financials
Bank of America Sold Unlocked Stakes in China Construction Bank (CCB)
Rumors turned true this week as Bank of America sold approximately 13.5 billion shares of CCB's Hong Kong-listed shares for a total of $7.3 billion. Major buyers of the stakes are believed to be  China Life  , Singapore's sovereign fund Temasek, and Chinese private equity fund Hopu.  Bank of America (BAC) still owns more than 25 billion H-shares of CCB after the sale.

First Issuance of U.S.-Dollar Denominated Bond from a Nonfinancial Firm in China
China National Petroleum Corporation, the parent company of PetroChina, raised $1 billion through the U.S.-dollar bond offering to fund overseas acquisition. The company plans to issue similar bonds in 2010 and 2011. Previously, only two large state-owned banks sold foreign-currency-denominated bonds in China.

Consumer
Pilot Projects on Consumer Financing Launched
China is planning to introduce consumer financing firms to spur domestic consumption. On a trial basis, consumer financing firms will be allowed to grant loans to individuals without collateral for buying durable goods and private consumption in Beijing, Shanghai, Tianjin, and Chengdu. The loan amount is capped at 5 times borrowers' monthly income.

Retail Sales Rose by 15% Year over Year in First Four Months of 2009
According to China's Ministry of Commerce, total retail sales grew 14.8% year over year in the January-April period with CNY 3.87 trillion ($570 billion). By region, retail sales in rural areas grew at a faster pace, up 16.7% year over year, compared with the 13.9% growth rate reported in urban areas. Much of the growth in rural areas is attributed to the government's recently launched subsidy program for home appliance purchases.

Basic Materials
China Puts a Brake on Steel Production Expansion
In an urgent notice issued this week, the Ministry of Industry and Information Technology urged steelmakers, especially the smaller ones, to refrain from increasing steel output at a time when supply is outstripping demand. While infrastructure build-out in China may create some new demand for steel, the collapse in steel export is mainly to blame for the imbalance of supply and demand in the market, according to an official from the China Iron and Steel Association. Data from the customs office indicate that finished steel export in April dropped by 71% year over year to 1.4 million metric tons, a historical monthly low since 2005.

Industrial
China to Invest CNY 300 Billion in Airports
According to a top official in charge of civil aviation, investments in airports are critical, as 25% of the airports (40 out of 160) currently in use won't have the capacity to handle the air traffic volume to and from their areas in 2010. Priority will be given to construction and expansion of airports in the inland areas of the country.

Iris Tan and Peter Liu contributed to this article.