China Economy - OCT 11

China's economy is slowing, but the authorities will try to maintain strong growth. Slower growth in China has also cast doubt on the pace of the global expansion. Growth has slowed gradually from 10.4% in 2010 and this downward trend continued in last month. Year-on-year industrial sector growth was lower in August to 13.5%, compared with 14% in July. Electricity production growth also slowed down by 3.2 pp, from 13.2% in July to 10.0% in August. Investment growth has been slowing in line with the overall trend of deceleration in economic activities although investment in real estate grew 33.2% y-o-y in August, slightly lower than 33.6% in July. Expansion in real estate has been fueled by investment in social housing schemes.

Officially, 8.7 million new housing units are now under construction, roughly on track with the government target of 10 million new units for this year. Y-o-y goods import growth has accelerated in August to 30.2% from 23.8% in July that takes total imports in the first eight months of the year to $1.1 trillion, up from $886 billion in the same period last year. This partly reflects rapid export growth as China’s exports contain a large proportion of imported components. China has been steadily tightening monetary policy in order to curb inflation, which reached 6.5% in July, the highest level since June 2008. The rate did, however, retreat slightly in August, to 6.2%, which is consistent with the view that inflation would ease in the second half of the year. More forward-looking indicators, such as the PMI, have also been trending lower in China.

PMI stood unchanged at 49.9 in September indicating a moderate growth trend for industrial activity. It seems that China is trying to engineer a soft landing in 2011, with economic growth averaging around 9% for the year. The Chinese economic authorities face the challenge that on one hand they try to reduce the inflation rate and at the same time they want to maintain economic growth ahead of the changeover to a new political leadership in 2012. Even amid interest rate rises, the authorities have maintained high levels of liquidity and have cut back on monetary sterilisation efforts. The y-o-y rate of growth of the broad money supply (M2) was still 13.5% in August, which is about the level of nominal GDP growth.

The broad measure of money supply, M2, has started to edge down slowly as this growth rate is the slowest pace in more than six years. There have been reports that small firms are facing liquidity problems because of their lack of access to credit although this has not changed the tight credit policy of the government. It is expected, therefore, that China’s economy will slow this year, but there is a possibility for China to spur growth in the face of an imported slowdown from OECD. If this were to happen, it would increase the risk of renewed inflationary pressure in 2012, during the political handover, leading to another effort to quash price rises in 2013, when inflation will be more entrenched.

A survey by the People’s Bank of China (PBC, the central bank) in the 3Q11 shows that inflationary expectations among urban Chinese had risen since the 2Q of the year. Elevated inflationary expectation could put upward pressures on wage increase, a trend that has already been noted for exerting some impact on rising production cost and reducing the competitive edge of the Chinese economy. The internationalization of China’s currency, the renminbi, has been on the agenda in bilateral relationships of China with advanced countries. In a recent visit by one of China’s vice-premiers to the UK in early September, the Chinese delegation is reported to have expressed support for the development of offshore renminbi financial services in the British capital, London.

This has followed an earlier visit by another vice-premier to Hong-Kong in August that also involved the promotion of renminbi internationalization. A major challenge for development of the offshore renminbi market is reinvesting the sums raised in Hong Kong back into mainland China. The internalization of the renminbi needs a deep financial system in China where convertibility of its currency for most part of the international transitions is limited and capital flow to and from the country still remains strictly controlled.