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The Chinese economy has clearly slowed down in the first quarter of 2012. Beijing has been accelerating its effort to boost economic growth, and we will start to observe the effect in several months.
China's economy grew at a lower-than-expected 8.1% in the first quarter, marking its slowest pace in three years, reported Dow Jones. Inflation numbers were still relatively low in March, so Beijing can be less worried about near term price increases as an impediment to monetary and fiscal loosening.
The consumer price index (CPI) rose to 3.6 percent in March from 3.2 percent in February, slightly higher than analysts' expectations, as bad weather pushed up food prices and authorities raised the price of fuel.
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Inflation is one of Beijing’s biggest economic concerns because rising prices, especially food prices, are highly correlated to social unrest. As of July last year, inflation recorded an all time high of 6.5 percent while gradually slowing through September and since then has experienced a sharp fall. “CPI was mainly pushed up by food prices, which resulted from an undersupply of vegetables due to relatively cold weather in March,” Li Huiyong, said a Shanghai-based analyst at ShenyinWanguo Securities. Food prices, regularly the source of government concern as they hit China's most sensitive populations, rose 7.5 percent in March.
Despite the economic slow down, China’s industrial output and retails sales provide some relief against concern of an immediate hard landing. Value-added industrial output in China rose 11.9% in March from a year earlier, accelerating from an 11.4% year-on-year increase in the January-February period. The rise also exceeded the median 11.2% gain forecast by 13 economists polled by Dow Jones Newswires.
In addition, retail sales in China rose 15.2% in March from a year earlier, accelerating from a 14.7% year-on-year increase in the January-February period. Retail sales in March rose 1.18% from February, when they rose 1.56% from January.
China returns to trade surplus but external demand still sluggish
Although China recorded a trade surplus in March, domestic demand is still low and the US and European economic slowdown have resulted in low export figures. In March, exports rose 8.9 percent over a year earlier to USD 165.6 billion, while imports grew 5.3 percent to USD 160.3 billion.
That growth was below China’s double-digit levels in recent years but in line with the combined January-February period, which analysts look at to screen out the impact of the Lunar New Year holiday, when companies close for a week or more.
Chinese demand has substantially weakened following Beijing’s inflation cooling measures and efforts to bring its economy back to a more sustainable level. In 2010, China recorded explosive double-digit growth following 2008’s economic stimulus package. Beijing tightened bank lending and imposed numerous restrictions on investments especially in the housing sector.
China’s flagging demand is a bad sign for commodities-exporting nations such as Australia and Brazil. It is also negative news for other Asian economies that rely on Chinese customers to buy their industrial components. The drop in export demand, triggered by Europe’s problems last year, prompted Chinese leaders to reverse course in December and promise more bank lending to shore up economic growth.
Beijing has already been easing monetary policy drastically.
In March, China's new CNY loans were the most this year and money-supply showed an obvious jump after Premier Wen announced Beijing will boost the domestic economy by cutting banks’ required reserves and help smaller businesses get financing.
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Local currency denominated loans were CNY 1.01 trillion (USD 160.1 billion) in March, the People's Bank of China said on 12 April, exceeding all 28 estimates in a Bloomberg News survey. M2, the broadest measure of money supply, rose to13.4 percent y-o-y. China's foreign-exchange reserves, the world's largest, hit a record USD 3.31 trillion as of 31 March, after dropping for the first time in more than a decade in the fourth quarter.
"March lending reflects the policy easing and support that have been in the works since the beginning of this year," said Wang Tao, Chief China Economist with UBS AG in Hong Kong.
Beijing needs to be careful about how to ensure it does not go to wasteful projects.
As Beijing is injecting more liquidity into the market in hopes of boosting economic growth, two things will likely happen if the process is not managed very carefully: Chinese banks will earn more profit and the non-performing loan ratio will rise.
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As a consequence of China’s distorted financial system, allocation of capital remains politicised, says Patrick Chovanec, Finance Professor at Tsinghua University’s School of Economics and Management in Beijing. A significant portion of the credit stimulus has gone into wasteful projects since late 2008, Chovanec says, and since that money is not creating real growth or productivity gains, it chases too few goods at higher prices.
When money is spent on zero or negative return, which is a classic case for China, we will observe an initial GDP boost as long as Beijing is injecting cash into system, but eventually we will see stagnant growth and inflation resulting in stagflation.
China’s distorted financial system produced mega state-owned banks that earn record profits year-on-year. Chinese banks enjoy a regulated spread between their lending rates and deposit rates. Therefore, the more money they are allowed to lend, the more profit they can make. However, the more generously they lend, the greater the risk they won’t be paid back, a risk that should be realistically tabulated and deducted from the earnings spread, explains Chovanec.
The Chinese economy is slowing down and Beijing has been pumping more money into it for the past three months. We hope Beijing has learned from its experience, and can carefully engineer the economy towards a sustainable growth path for the remainder of 2012.
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