China's economic dilemma: Woes lie beyond its borders

Posted at 09/10/2012 9:32 AM | Updated as of 09/10/2012 9:33 AM

BEIJING - China's August trade data is set to reveal an awkward truth. For all the strength and flexibility policymakers in the world's second-biggest economy have, the sector of activity they can do least about is causing them the biggest problem.

August export growth is forecast by analysts in a Reuters poll to have been just 3 percent year on year, which would make it the weakest August since 2009 - near the depths of the global financial crisis and underlining President Hu Jintao's warning of the "grave challenges" posed by the world economy. The data is due on Monday.

Such weak growth would be grim news in a country where exports generate 25 percent of gross domestic product, support an estimated 200 million jobs and where analysts already expect the economy to have its weakest year of expansion since 1999.

Some economists fear the outlook is so poor that China may miss its official 7.5 percent growth target for 2012 without a fresh round of swift policy stimulus on top of the monetary and fiscal easing undertaken since last year and the $150 billion-worth of infrastructure projects announced last week.

Those fears were amplified by data on Sunday showing industrial output growth hit its weakest annual pace in August in more than three years.

The problem is that despite deep government pockets, record tax receipts, a budget in surplus in the first half of the year and monetary policy still on the tight side even with inflation near two-year lows, there is little policymakers in Beijing can do to stimulate demand beyond their borders.

"Difficulties are increasingly emanating from the external sector," said Alistair Thornton, China economist with IHS Global Insight in Beijing.

"More support measures, such as tax rebates, are in the pipeline for the exports sector, but they can simply aim to keep businesses afloat. They have little impact on aggregate demand."

China's biggest customers are the debt-ridden, recession-bound European Union and the still struggling United States.

Without a big boost in demand from those two economies, Beijing policymakers face an uphill battle.

"China needs three engines (exports, investment and consumption) to drive growth and stabilising investment is very important. However, it is not the way out to focus only on government investment," Wu Xiaoling, a former vice governor of the central bank, told reporters at a forum in Beijing on Sunday.

INVESTOR FOCUS SHIFTS

The focus of investors has clearly shifted though to more aggressive efforts to stimulate domestic activity to compensate for declining external demand.

They are worried that six successive quarters of slowing growth risk sliding into a seventh in the third quarter despite the "fine-tuning" of economic policies which began in November 2011.

Two interest rate cuts, the freeing of an estimated 1.2 trillion yuan ($190 billion) for new lending by cutting required reserve ratios (RRR) at banks and a raft of tax tweaks have so far failed to halt the slide.

Instead China's factories are running at their slowest rate of expansion since May 2009, data on Sunday showed. Industrial output growth in August eased to 8.9 percent year on year, according to data from the National Bureau of Statistics (NBS) on Sunday.

Surveys of purchasing managers in the manufacturing sector earlier this month showed concerns growing about new business, suggesting that factories will run inventories down further before they begin to turn production up again.

Those data points, together with statistics showing that annual inflation was 2 percent in August - well below the government's 4 percent target for the year - suggest to Zhang Zhiwei, chief China economist at Nomura in Hong Kong, that Beijing will take more policy steps to boost growth.

"Leading indicators suggest both property and infrastructure investment will likely pick up in coming months. This reinforces our view that total investment growth will pick up soon and GDP growth will rebound above 8 percent in Q4," Zhang said.

A surge in new project investment in August back his view. Zhang says the annual rate growth was 33 percent in August versus 25 percent in July and he expects it to top 40 percent in coming months as China approves more infrastructure spending.

FIXED ASSET INVESTMENT

China's growth is clearly being supported by fixed asset investment and a double-digit rise in Sunday's data underlined that fact.

Fixed asset investment, which accounted for half of China's net economic growth in the first-half of 2012, grew 20.2 percent between January and August compared to the year earlier period. That was a touch below expectations for a 20.4 percent expansion but was stronger than other indicators.

Officials last week revealed they had given the green light to 60 infrastructure projects worth more than $150 billion, as Beijing seeks to energise the economy. The announcement fuelled investor hopes the world's growth engine may get a lift in the fourth quarter of the year and beyond.

The approvals are roughly a quarter of the total size of the massive stimulus package unleashed in response to the global financial crisis in 2008. Fixed asset investment contributed 3.9 percentage points to China's 7.6 percent second-quarter growth.

Chinese leader Hu urged Asia-Pacific nations on Saturday to speed up infrastructure development to help face the "grave challenges" from the global economy.

A political imperative is also at play, given the upcoming once-a-decade handover of power at the top of China's Communist Party leadership. Expected later in the autumn, the showcase event is supposed to take place against a backdrop of economic prosperity and stability.

"Putting together economic fundamentals and timing of major political events, we reckon there will be a second round of policy easing including RRR cuts and some fiscal stimulus," economists at Bank of America/Merrill Lynch wrote in a note to clients after Sunday's data.

"Adding home supply and improving urban infrastructure are the two best ways to contain home prices, speed up urbanisation and increase social welfare," they added.

Qiu Xiaohua, former head of the National Bureau of Statistics and now a senior researcher with the China National Offshore Oil Corporation (CNOOC), told a forum in the city of Xiamen on Sunday that the government still had room to act to bolster growth - and urged it to do so.

"I think the government should accelerate the pace and further increase the strength of policy fine-tuning to give a lift to the economy," Qiu said, adding that he expected third-quarter growth to slow to 7.4 percent or less.