Last month, we reported that China’s economy enjoyed a strong first half of 2008, despite
the fact that economic growth did not approach 2007’s figure of 11.9%. We also noted that
growth is expected to slow significantly in H2 and as we enter 2009. Now, early indicators
are beginning to show that these assertions are coming true.
While China is moving away from exports and toward a high-tech and domestic consumer
driven economy, the country’s growth still remains very much export-driven. When export
growth slows, economic growth slows. Export growth seems to be falling at an eye-opening
rate, with volume growing at only 5.9% in June over the same period in 2007. By
comparison, in July 2007 export volume was still growing upwards of 28%.There are a
number of factors that have contributed to the problem. These include the sub-prime driven
slowdown in the West, Beijing’s reduction of VAT rebates for many exporters, and the rapid
appreciation of the RMB in 2008, among others.
The effect of the slowdown in the West is obvious—the U.S. and Europe are consuming less,
and orders to Chinese exporters in recent months have suffered as a result. The reduction
in VAT rebates was introduced last summer by Beijing as part of a series of tightening
measures designed to cool the economy, which at the time was in danger of overheating.
The effects were delayed, and have really begun to hurt exporters in 2008; many firms that
export low-margin products depended on those rebates to maintain profitability. Regarding
the currency appreciation issue, rapid RMB appreciation hurts exporters because the USD
payment they receive for their goods becomes less valuable.
Beijing has responded to the signs of a slowdown, declaring a change of monetary strategy.
In a recent Politburo meeting, the directive was altered from a strategy of tightening and
inflation control to a strategy of maintaining reasonably fast growth while controlling
inflation. “We must maintain steady, relatively fast development and control excessive price
rises as the priority tasks of macro adjustment,” said President Hu Jintao. As part of the
alteration, loan quotas have already been raised by about 5% for small- and medium-sized
enterprises (SMEs), and we’ll likely see Beijing slow the appreciation of the RMB for the
remainder of the year. VAT rebates have also been bumped up for textile manufacturers.
Along with a number of other industries, textile exporting had been hit hard by the reduction
in VAT rebates due to its lower margins. Although China is moving away from economic
dependence on lower value-added exports, regulators are now taking steps to make the
process more gradual in an attempt to avoid too rapid an economic slowdown and a
subsequent hard landing.
We’ll also keep an eye on how the People’s Bank of China (PBOC—China’s central bank)
responds to the country’s new change in economic strategy. For the last year and a half,
PBOC has used a series of hikes in the required reserve ratio for banks and hikes in interest
rates to remove money from circulation, control loan growth, and attempt to reign in
inflation. With the new focus on maintaining growth rather than slowing growth, and with
inflation control still at the top of the agenda, it will be interesting to see how PBOC alters its
Incidentally, although many had expected a post-Olympic malaise, the impending slowdown
has almost nothing to do with the Olympics. Despite the significance of the Games, they
have much less to do with the state of the economy than the factors mentioned above.