We have revised down our 2012 China GDP forecast by another 0.3 percentage point to 7.9 percent on further weakness in second-quarter economic growth and a downward revision to our US economic outlook.

First, we believe second-quarter GDP growth will be weaker than our previous expectations (7.1 percent quarter on quarter, and 7.7 percent year on year) as May industrial production surprised to the downside and coal/steel prices and consumption continued to weaken in early June.

Anecdotal evidence from raw materials sectors in recent days suggested that inventory de-stocking is continuing. In addition, the base effect is likely to become highly unfavorable for industrial production growth in June.

We thus think that year-on-year industrial production growth in June will likely be the worst in the year, or at below 9 percent. This should put average industrial production growth at only 9.3 percent in the second quarter, compared with 11.6 percent in the first quarter.

Taking into consideration that industrial production accounts for 40 percent of GDP and the monthly figure is a bit biased to medium- and larger-size companies that perform worse than the overall industrial sector, we believe second-quarter GDP growth will slow to 7.5 percent year on year and 6.2 percent on a quarterly basis.

Second, we have trimmed our second-half forecast slightly, primarily due to Deutsche Bank's downward revision to US GDP forecasts (by 0.5 percentage point for the third quarter and fourth quarter's annualized sequential growth, respectively).

Our US economists have become somewhat less optimistic due to weaker-than-expected defense spending as well as the negative spillover effect of European uncertainty on American consumer and business spending.

As a result of the weaker US outlook, we have trimmed our sequential GDP growth forecast for China marginally, which in turn translates into a 0.3 percentage point reduction in year-on-year GDP growth forecast for the second half of this year from our previous projection. Our new forecasts are that year-on-year GDP growth will recover modestly to 7.9 percent in the third quarter and 8.2 percent in the fourth quarter.

In addition to our downgrade to this year's GDP forecast, we also marginally revised down our 2013 forecast by 0.2 percentage point to 8.4 percent. Again, this largely reflects our bank's cut to expected US GDP growth next year by 0.5 percentage point, which should negatively affect the export outlook for China.

Declining prices

In May, most raw material prices including steel, nonferrous, and chemicals, fell by 2 to 5 percent on a month-on-month basis. This trend appears to have continued in early June. We believe this reduction in raw material prices, as well as the recent cut in benchmark lending rates, should boost earnings in a few sectors: 1) auto sales growth has recovered from virtually zero a few months ago to 8 percent year on year in May, and additional policy stimulus such as a trade-in policy is likely to boost auto sales further. Thus, a decline in steel and petrochemical prices would bode well for the auto sector given its demand recovery; 2) demand for properties should be given a boost due to the 25-basis-point cut to benchmark mortgage rates; 3) the power sector is now benefiting from a fall in coal prices and a cut in lending rates, which should more than offset the weakness in power production; and 4) finally, the power equipment sector, with stronger government investment to address the power shortage issue as well as the recent resumption of nuclear projects, should enjoy the benefit of a fall in steel prices.

The article was selected and edited based on the Asia Economic Monthly note issued by Deutsche Bank on June 12.