Yuan faces upward pressure as trade surplus to continue

The anticipated further rebound in trade surplus in the second half, coupled with other forms of capital inflows, points to continued upward pressure on the yuan.

China's import growth came in lower than expected at 19.3 percent year-on-year (YoY) in June, compared with the upside surprise of 28.4 percent posted in May.

Meanwhile export growth moderated to 17.9 percent from 19.4 percent in May. As a result, the trade surplus widened to $22.3 billion in June, the highest in seven months, according to data released by the Customs Administration on Sunday.

The slowdown in June trade growth reflects slowing sequential momentum and a high year-earlier comparison - both for exports and imports. This is not surprising, as the recent decline in the PMI export orders and import indexes pointed to weaker external and domestic demand.

Taking into account the rise in import and export prices, the real import growth should have slumped to around 2 percent year-on-year (YoY) in June from 10 percent in May, and the export growth should have fallen to around 7 percent from 9 percent in May.

In particular, import volumes of most major commodities fell in June, while YoY import price growth remains elevated by our estimates. Crude oil declined 11.5 percent compared with an increase of 20.8 percent in May, steel products were down 18.4 percent versus a decline of 5.9 percent in May, and copper imports fell 14.7 percent versus a drop of 35.8 percent, and aluminum imports fell 13.5 percent versus a decline of 20.8 percent.

The trade surplus stood at $44.9 billion in the first half of 2011, down 18.2 percent from a year ago. It is worth noting that the surplus from processing trade surged to $164 billion in the first half, three times that of the overall trade surplus, and up 19.8 percent YoY.

Barclays maintains its forecast of full-year export growth of around 20 percent and full-year import growth of 23 percent. An expected stabilization in export growth, combined with slowing import growth, suggests a further rebound in the trade surplus in the second half to $130 billion. This, together with other forms of capital inflows, points to continued upward pressure on the yuan against the US dollar in the second half.

Despite challenges from rising labor costs, yuan appreciation and tight credit conditions, the contribution to total trade by small and medium-sized private enterprises (SMEs) increased in the first half, outperforming SOEs and foreign-invested enterprises.

Total imports and exports by SMEs accounted for 27 percent of the nation's total in the first half, and the sector's growth of 38.8 percent exceeded the 25.8 percent growth for the country's overall trade. Also, exports of labor-intensive sectors continued to grow at a relatively fast pace - eg, textile products rose 29 percent, clothing increased 24 percent, and suitcases were up 39.2 percent.

These figures were in line with some anecdotal evidence, which suggested that many SMEs/exporters have managed to survive the challenging environment, thanks to their relatively smaller scale and flexible business models. These figures may help alleviate concerns over the "closure of factories and surge in unemployment", and hence, are supportive of further gradual yuan appreciation.