China data show uneven economic recovery, policy dilemma

By Aileen Wang and Nick Edwards

BEIJING (Reuters) - China's uneven economic recovery signals a looming dilemma for policymakers as official data released at the weekend showed inflation at a 10-month high in February while factory output and consumer spending were weaker than forecast.

Data from China's National Bureau of Statistics showed the consumer price index rose 3.2 percent in February from a year ago, versus expectations of a 3.0 percent rise, while annual industrial production (IP) growth in January and February combined at 9.9 percent was the lowest since October 2012 - the starting point of China's nascent economic recovery.

The NBS numbers revealed state-mandated fixed asset investment (FAI) was the key driver of economic growth in the first two months of the year, up 21.2 percent and the strongest in 12 months, while annual retail sales growth of 12.3 percent was the slackest January and February combined since 2004.

"This data shows that the economy is in the process of a mild recovery and that it is still fragile," Xu Gao, chief macro-economic analyst at Everbright Securities in Beijing, told Reuters. "It faces a lot of uncertainties."

The key uncertainty is how much the data has been distorted by the fall of China's annual Lunar New Year holidays, which were in February this year and in January in 2012 and which typically see factories shut up shop for two weeks.

The risk is that the economy needs monetary policy tightened to cool prices before industrial activity and retail sales regain momentum lost last year as the Chinese economy delivered its slowest full year of growth since 1999, at 7.8 percent.

MIXED PICTURE

"January-February data have painted quite a mixed picture," said Ren Xianfang, senior economist at consultancy IHS Global Insight in Beijing.

"Property and credit data point to signs of overheating, whereas IP and FAI, as well as early indicators for manufacturing, such as PMI, have languished again," she wrote in a note to clients.

Purchasing managers indexes (PMIs) in the manufacturing sector released on March 1 had already flagged February factory activity at multi-month lows as domestic demand dipped.

Excess capacity would appear to remain ample, given Saturday's producer price data that showed prices at the factory gate remained in deflation in February, falling at the same 1.6 percent rate year-on-year as they did in January.

Though a 0.2 percent month on month rise in producer prices offer some sign that demand for Chinese goods is stabilising.

The picture for foreign demand, however, remains uncertain, despite a 21.8 percent surge in February exports versus a year ago that was reported on Friday.

The export bounce is, at face value, a sign that China's modest economic revival is intact and suggestive of global demand being on the mend, but imports were surprisingly weak, falling 15.2 percent from a year earlier to 13-month lows and highlighting vulnerability lurking in the domestic economy.

"China's economy is increasingly being driven by domestic demand and recent data cast doubt on a strong recovery," Zhang Zhiwei, chief China economist at Nomura in Hong Kong, said.

POLICY CHALLENGE

Lending data saw a surge in January and economists polled by Reuters expect February's numbers to be well above November and December levels when the data is released later this month, suggesting that monetary conditions remain loose.

The People's Bank of China will target 8.5 trillion yuan in new local-currency loans in 2013 and 13 percent annual growth in M2, the official China Securities Journal has reported.

Relatively easy liquidity has fuelled investment in China's notoriously frothy real estate sector - property investment jumped 22.8 percent in January and February combined from 2012 - pushing up home prices and triggering hawkish talk on property tightening from Beijing policymakers to contain the risk of an asset bubble rapidly inflating.

Food prices may have been the biggest distorting factor in the February inflation data, gaining 6 percent year on year and most likely a sign of increases ahead of Lunar New Year festivities.

The mixed messages from the data make any policy tweaks particularly sensitive - especially as China puts the finishing touches to a government transition that began in November and is set to be sealed by March 17 with Xi Jinping and Li Keqiang taking over as president and premier, respectively.

"The Chinese government is caught in the dilemma of dealing with slower growth and yet higher inflation again," Ren at IHS said, adding that the government had little real room to wiggle on the monetary policy front while stabilizing growth.

"The government's policy challenge for this year is to strike a balance between containing an asset bubble and pushing the economy out of the growth malaise," she said.

(Editing by Robert Birsel)