News Room - Business/Economics

Posted on 18 Jul 2008

China Slows, But How Slow?

China's actual growth rate is now irrelevant: like all statistics its essentially a backward looking system of measuring growth in Gross Domestic Product. 

China's growth remains solid, but it is slowing: the 10.1% annual rate in the June quarter was the slowest since 2005 and it had an immediate impact on global markets, pushing oil down to its lowest level in six weeks and under $US130 a barrel.

The question we now have to wonder about is: is this temporary, structural, or simply the Chinese economy slowing after several years of pell-mell growth.

And, remember, 'slowing' is relative. China is not slowing like the Australian economy, nor will it end up like the Japanese, US or European economies. It could be just a normal reaction to a tightening of monetary policy by the authorities to prevent a highly inflationary bubble developing.

It matters here in Australia because if it's slowing sharply (to a level that will still be solid by any measurement), it will have a knock-on effect here on share prices, on economic growth, inflation and interest rates over the next year, at least.

Figures released yesterday show that China's GDP grew 10.1% in the second quarter from the second quarter of last year; down from 10.6% in the March quarter, and noticeably lower than the upwardly revised 11.9% average for all of 2007.

And, as 'leaked' to Western newsagencies late last week, inflation slowed to 7.1% in June, from 7.7% in May and over 8% in earlier months.

However factory-gate inflation accelerated to 8.8% – the fastest annual rate since the mid-1990s – from 8.2% and possibly a more accurate signal on the price pressures in the Chinese economy, given the extensive price controls.

The economy is clearly slowing and it raises the following questions: do the official numbers acknowledge this slowdown fully? And what does this slowdown mean for the sharp appreciation in the Chinese currency, which is up 21% since it floated three years ago; with a noticeable acceleration in the rate of increase in recent months.

That appreciation has helped cut the cost of imports, enabling Chinese steel mills for instance to pay huge price rises for Australian iron ore and coal.

RBA Governor, Glenn Stevens made the significant point in his speech this week in Sydney that emerging economies should be taking action to slow growth to help take the pressure off western economies and central banks.

He said that emerging economies had been running loose and accommodating monetary policies, and even though growth was still strong, so was price inflation. That's a view that was supported by the International Monetary Fund overnight which urged emerging economies to fight inflation by lifting interest rates.

Central banks in Thailand, Vietnam, Indonesia, India, The Philippines and South Korea have all tightened policy in recent months as inflation has soared, driven by accelerating oil and fuel costs and a surge (now easing) in food prices.

China has been trying to slow its economy through old-fashioned attempts to restrict credit growth through quantitative controls like increase the size of the reserve asset ratios banks must use to quarantine more assets from being recycled as loans.

Interest rates have not risen and still remain negative, even as inflation eases. Loan quotas are also being used, and outright bans have been reported.

Like its neighbours, China is walking a tightrope between slowing growth and surging inflation.

Price controls remain in place even though there are reports that China faces a tough summer of power shortages because of soaring coal prices and inadequate pricing has forced many small, polluting power stations to shut down. Lead, zinc and aluminium processors have cut production for the next quarter to try and help limit their demands on power supplies, but also to try and bolster sinking world prices.

Much might change later in the year, after the Beijing Games are over and foreigners have left China. Price controls might come off and then there's the rebuilding of the earthquake hit parts of Sichuan which will boost the economy (which should in turn boost Australian resource suppliers because more steel will be needed).

The question for after the games is: will the Government allow China kick higher, having had the economy settled with some tightening, or will the slide continue (the stockmarket is depressed, compared to the seemingly endless boom of last year)?

If China rebounds towards the end of this year, where will oil copper and a host of other commodity prices end; higher?
 
We should not underestimate the fear the Chinese Government has of social unrest, driven by rising food costs and scattered examples of dissent (Tibet and Muslim separatists are the current groups of interest for the security authorities).

Those fears are why price controls were imposed last year, despite their distorting effect on oil prices, profits, demand and the market; its why controls were imposed on power charges, food prices and a host of other state costs.

Second quarter growth was the slowest since 2005. Exports are easing because of slowing demand in the US and to a lesser extent Europe and Asia. Imports are soaring because of the impact of the more expensive Yuan and price rises for oil, coal, iron ore, grain and oilseeds.
 
Second quarter GDP growth cooled for the fourth straight quarter.

China's export growth slowed to 21.9% in the first half from 25.7% for all of 2007, as US demand weakened, and prospects for the rest of the year have deteriorated.

Price pressures have has eased from February's 12-year high of 8.7% on smaller gains in food prices and those price controls.

Will the government relax controls straight away or phase them out? Phasing them out would allow a slower rebound in prices.

And, will the Games mean another slowdown in growth as businesses are closed for a month in and around Beijing?

Post-games, there could be a rebound in the 4th quarter simply for that reason, while inflation could rise as well.