China’s Growth To Slow Slightly In Q3, Still 10%+

The eurozone debt crisis has changed the short-term plans of China’s economic policymakers. The second half of this year was meant to be when the stimulus measures put in place for the global financial crisis were unwound and the assets bubble they produced deflated in measured manner so growth could continue at a brisk but not dangerously rapid pace. Instead they are having to deal with the consequences of the fiscal austerity measures being put in place by indebted European governments.

Those will affect China directly as Europe is the main export market for its manufacturers and indirectly though the brake they will impose on global economic recovery and an increased risk of a double-dip recession. For now, China’s leaders are signaling that they will do what is necessary to sustain growth. That will mean no rush to wind down existing stimulus measures and a readiness to provide more should a slowdown in the growth rate warrant it.

Absent spectacularly negative events in Europe, we don’t think that will be needed. We still expect the economy to grow by 10% in the third quarter, thanks to strong domestic demand, recovery in the U.S. and the revival of world trade. That would be down from the 11.9% growth rate of the first quarter, but still comfortably above the 8% level that sends political alarm bells ringing in Beijing and opens the public spending coffers.

The uncertainty that pervades policy makers will likely mean a pause in their slow but steady tightening of monetary policy already underway. Fixed asset growth is slowing, showing that some of the measures the authorities have been taking to deflate the property bubble are having an effect (the euro crisis has taken care of the bubble in stock prices). The central bank has raised banks’ capital reserve requirements three times this year to rein in the lending that is fueling the property boom. However, new bank lending is proving more intractable than the central bank would like: 3.4 trillion yuan ($498 billion) of new loans were made in the first four months of the year, on track for a number for the full year closer to last year’s 9.6 trillion yuan than this year’s target of a reduction to 7.5 trillion yuan.

Similarly consumer price inflation is bumping up against its targets (3% for the year). Beyond soaring housing prices, food prices are up following a long run of wretched weather in key crop growing areas. Commodity prices are rising worldwide and labor cost pressures are increasing beyond the well publicized wage rises at Foxconn and Honda. Both those trends showed up in the 6.8% increase in the producer price index in April. Key questions are how much of those price pressures can manufacturers pass onto domestic and export customers, and with what effect on sales. None the less, inflation pressures aren’t so great that the central bank needs to raise interest rates again. Given the overall uncertainty over the economic outlook, it has no great desire to do so anyway.

Keeping the economy steady and growing until it is clear what the fallout from the euro crisis is remains the priority. A wild card for the economy is the leadership succession. We are seeing evidence of the behind the scenes factional jostling for position breaking through in foreign policy every now and then. No reason to suppose that couldn’t happen with economic policy, too, especially as the two are now so connected. Arguably with the yuan revaluation issue, it already has.

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