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Wednesday, July 20, 2005

China Growth Continues To Be Strong

Chinese economic growth continued at a 9.5% y-o-y rate during the second quarter of this year. This was an increase from the 9.4% rate of the first quarter. Imports slowed down, and exports continued at the same rate. The staple behind the growth was fixed asset investment which increased 25.4% to 3.29 trillion yuan in the first half after climbing 22.8% in the first quarter. Growth in real-estate investment slowed to 23.5% in the first half from a 26.7% pace in the first quarter. In fact gross fixed asset investment was running at the unsustainable rate of 49% of GDP in the first quarter.

Why is this acceleration, contrary to expectations, taking place? Well Denise Yam and Andy Xie(both Morgan Stanley) suggest that:

"Strong opposition from interest groups (local governments, financial institutions, business sectors) held policymakers back from sufficient macro tightening to tame the investment-driven cycle in China. The objectives of social, economic and political stability leave the government with the arduous task balancing interests among economic sectors, geographical regions and between short- and long-term considerations. Strong growth is often preferred as job creation is seen as a powerful input to social stability."

They believe however that the investment-driven cycle will come under the pressure of its own weight - overcapacity, unfavorable pricing, reduced cash flow and shrinking margins and that "deteriorating profitability and corporate cash flow are set to force a slowdown in capex, bringing down the unsustainably strong economic growth". In this latter context this may be relevant:

A senior Chinese central bank official has said that commercial lenders should ensure that funds continued to flow to healthy companies amid signs of an easing of the country’s tight credit policies.....“Commercial banks should ensure lending of working capital to enterprises that are able to secure considerable market share, make money and create jobs,” said Zhang Xiaohui, the head of the monetary policy department of the People’s Bank of China, in an interview with the China Securities Journal.

This may well indicate that the corporate cash flow problem Xie so fears may be arriving.

Amazingly consumer inflation was only running at a 1.6% YoY in June, which with all the excesses of growth must mean underlying deflationary forces are strong. As Xie and Yam indicate in real terms retail demand grew by only 12% YoY, similar to the pace in 1Q05, and faster than that in 2004 (10%), and a reducing portion of GDP when you look at the fixed investment numbers in comparison.

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