China: On track for a (not so?) soft landing

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China: On track for a (not so?) soft landing

China: On track for a (not so?) soft landing

Asia Pacific Economic Outlook, September 2012

Although China’s economy continues to generate disappointing economic news, the soft landing scenario remains likely, given the efforts by the government to offset weak external demand.

China’s economy continues to generate disappointing economic news, but the soft landing scenario remains likely given the efforts by the government to offset weak external demand. The main problem, of course, is the situation in Europe. The government reported that, in July, exports were up only 1 percent from a year earlier while imports were up 4.7 percent. The weakness in exports reflected the problems in the global economy, but mainly in Europe. Exports to Europe were down 16.1 percent, while exports to the United States rose a very modest 0.6 percent.

The European situation is so worrisome that it has elicited comments from China’s leadership. In a meeting in Beijing with Germany’s Chancellor Angela Merkel, China’s Premier Wen Jiabao called for the peripheral countries of Europe to do more to reform. He said, “The main worries are twofold: first is whether Greece will leave the Eurozone. The second is whether Italy and Spain will take comprehensive rescue measures. Resolving these two problems rests with whether Greece, Spain, Italy, and other countries have the determination for reform.”

Premier Wen also commented on what China can do. He said, “China is willing, on condition of fully evaluating the risks, to continue to invest in the Eurozone sovereign debt market.” China is clearly worried about Europe’s prospects. The European Union was China’s largest export market until recently, but as exports to Europe slowed, the United States became the largest market for China. The speed of recovery in China will depend, in part, on what happens in Europe. It is not clear, however, that Chinese purchases of Eurozone debt will make much of a difference for Europe except to boost the value of the euro—something Europe doesn’t need.

The export problem has affected the health of China’s industrial economy. A preliminary purchasing manager’s index for Chinese manufacturing (published by HSBC/Markit) fell from 49.3 in July to 47.8 in August. This was the weakest reading since November and the tenth consecutive month that the index was below 50.0, indicating acceleration in the decline of manufacturing activity. This index was consistent with other indicators that suggest worsening performance. Export growth has stalled, and foreign direct investment is down. In addition, the Chinese government reported that industrial production was up 9.2 percent in July from a year earlier, and retail sales were up 13.1 percent from a year earlier. Both figures were considerably weaker than market expectations.

Chinese Premier Wen Jiabao recently said that lower inflation in China creates more room to use monetary policy to stimulate the economy. His statement could be a signal that further easing is imminent.

These indicators suggest the possibility that the much-heralded soft landing could be a bit harder than expected. As such, the government may choose to boost its efforts to stimulate the economy. That is because such efforts have so far not yielded positive results. Easing of monetary policy should have resulted in a boost to credit activity, but the Chinese government recently reported that local currency lending by Chinese banks declined dramatically from 919.8 billion yuan in June to 540.1 billion yuan in July. This means that the easing of monetary policy is not yet having the desired impact on credit markets. However, even as the government worries about a lack of credit creation, it is also worried about the quality of existing bank loans. China’s bank regulator is asking property developers to sell properties more quickly in order to generate sufficient funds to service their debts. The number of loans considered at risk has been rising. However, the Chinese government has tried to stymie property speculation by imposing limits on the ability of individuals to obtain mortgages. Consequently, developers are having greater difficulty unloading newly built properties. The government said that it will not ease mortgage lending rules. The government’s efforts to stymie bank losses tend to offset efforts to boost credit.

One possibility is that the central bank will ease monetary policy further. Chinese Premier Wen Jiabao recently said that lower inflation in China creates more room to use monetary policy to stimulate the economy. His statement could be a signal that further easing is imminent. Recent data indicates that inflation has eased, credit markets have stalled, and exports have decelerated. As such, a case can be made for more action. Such action could entail further cuts in interest rates and a further reduction in banks’ required reserves.

Of course, monetary policy action must also take account of inflation. And while inflation is down, the rapid increase in global food prices is a concern. That is because a large share of consumer spending in China is devoted to food. Consequently, China’s government will likely release corn and rice from state reserves in order to suppress inflation. The global price of grain has increased dramatically due largely to the serious summer drought in the United States. The release of Chinese reserves is likely to cause a reduction in Chinese imports of U.S. corn, thereby reducing the impact of rising global prices. This action is expected to help China keep inflation at bay so that it may focus on efforts to revive growth.

 

About The Author

Ira Kalish

Ira Kalish is director of global economics, Deloitte Research, Deloitte Services LP.

China: On track for a (not so?) soft landing
Cover Image by Stephanie Dalton