China’s Economic Slowdown Triggers Guesses on Policy Modification

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By Vivian Ni

Oct. 21 – China’s third-quarter economic statistics showed the lowest GDP growth rate in the past two years, according to the National Bureau of Statistics (NBS) on Tuesday. The continuing economic slowdown – amid the deteriorating external environment and slightly tamed domestic inflation – has made economists wonder whether or not some adjustment in the current tightening policy is approaching.

Slowdown in GDP growth
China’s GDP growth rate during the third quarter edged down to 9.1 percent, from 9.5 percent in the second quarter and 9.7 percent in the first quarter. The figure – although still considered by the NBS as an indicator representing steady and rapid growth – appears to be lower than the medium estimate of 9.3 percent by Bloomberg and 9.2 percent by Reuters.

The deceleration in foreign demand, largely caused by the lingering financial crisis in the West, has contributed to China’s economic slowdown. The world’s largest exporter has seen its trade surplus in September decrease by 12.4 percent from a year earlier to US$14.5 billion, and has seen its shipment growth to its largest export market Europe more than halved from 22 percent to 9.8 percent.

In contrast to its plummeting export performance, China’s real economy and domestic demand remain strong. Industrial production in September increased by 13.8 percent from a year earlier, showing an upward trend compared to August; investment in fixed assets over the first three quarters climbed 24.9 percent in nominal terms, only a moderate 0.7 percent decline compared to growth during the first six months; expansion in retail sales accelerated with a year-on-year increase of 17 percent in nominal terms, mainly bolstered by recovered sales of automobiles, household appliances and construction materials.

At an NBS press conference held on Tuesday, the NBS spokesperson Sheng Laiyun emphasized the increasing private participation in China’s fixed asset investment.

“Between January and September, private investment (on fixed assets) surged by 34.2 percent … taking up 59 percent of total investment on fixed assets during the period,” Sheng said.

The solid endogenous dynamics China is showing have reduced analysts’ concerns over an overall recession in the Chinese economy. Barclays’ Capital Asia recently said in a research note that China’s third-quarter growth pace – which is broadly in line with expectations – appears to remain on track for a soft landing. A World Economic Outlook report published by the International Monetary Fund last month predicted China’s GDP growth to average 9 percent to 9.5 percent between 2011 and 2012, 0.9 percent to 1.4 percent down from the economic expansion rate in 2010.

However, the Chinese economy is still facing some serious challenges. Wang Tao, UBS’s China economist, says the country’s GDP growth could drop to as low as 7.7 percent during the first quarter of 2012 if a “global downturn or recession” takes place in the near future and hurts domestic production.

Experts even predict a possible policy shift in case the external market conditions deteriorate more gravely. Wang Jian, a senior researcher with the National Development and Reform Commission (NDRC), told China Daily that “if the economic slow-down is more serious, China will probably cut interest rates or roll out new stimulus packages worth trillions of yuan.”

Lower level of inflation
The growth in consumer price index (CPI) has seen a decline for the second straight month in September, to 6.1 percent from July’s 6.5 percent and August’s 6.2 percent. Although inflationary pressure remains high, Beijing seems to be showing more confidence in putting elevating prices under control.

At the press conference, Sheng pointed out the factors that help restrict price increases – such as the overall economic slowdown and tightened liquidity – are increasing. According to the financial report recently released by People’s Bank of China, by the end of September, China’s money supply M2 experienced the slowest growth (13 percent) in almost a decade, and the newly increased RMB lending (RMB5.7 trillion) also reached the smallest size since December 2009.

Ma Jun, an economist with Deutsche Bank AG, forecasts that the CPI will drop to 4 percent in December. Morgan Stanley analysts also predict the inflation to decline to below 4 percent by the end of the year.

The Chinese government has made significant efforts to rein in inflation over the last year, mainly by raising interest rates and constraining lending. However, the tightening measures turned out to be a double-edged sword that has also hurt small and medium-sized enterprises (SMEs). Reports of SME bankruptcies surged recently in many coastal cities due to a lack of financing, prompting a government policy modification towards them. Last week, the central government vowed to cut taxes and offer greater financial support to SMEs, revealing a sign of sector-specific easing.

Potential policy modification
While most economists believe a complete policy reversal is not likely to appear at the moment as inflationary pressure remains relatively high, most of them agree some sector-specific easing is needed to relieve the financing difficulties facing SMEs. NDRC researcher Wang predicted that any policy relaxation would start with larger loan quotas for small companies.

The research note by Barclays’ Capital says that a broader-based easing would depend on export growth and labor market conditions. It also suggests the government may not take measures to reverse its monetary tightening policies before early December, when the Central Economic Work Conference will be held.

Yao Wei, an economist at Societe Generale AG, emphasized that policy easing – if started – may proceed in a gradual pace, because the slowdown “will be less dramatic than that in 2008.”

“The central government is likely to roll out more policy easing from week to week,” said Yao.

A possible easing measure may start with a reserve requirement ratio (RRR) cut at banks. Huang Yiping, an economist with Barclays Capital, said he would not rule out the possibility of an RRR cut by the end of this year and the RRR reduction may happen at small banks first.

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