Gl=: China's Economy Is Cooling - Expand Your Insight

Global Economy
China’s Economy Is Cooling

Dong Fu and Jahyeong Koo look at economic conditions over the past few months in China.

"Clearly through the second quarter, where their quarter-by-quarter rate of growth really slowed virtually to a halt, they exhibited considerable removal of very major elements of growth. However, they don't seem to be sinking much further."
—Fed Chairman Alan Greenspan on the Chinese economy, July 20, 2004

By the end of first quarter 2004, there had been clear signs of overheating in the Chinese economy. Industrial production increased 17.7 percent, and fixed investment was up 43 percent year-over-year. Shortages of raw materials and energy became acute, pushing up prices. In response, the Chinese government adopted both administrative and economic policy measures to cool the economy—cutting unauthorized investment projects, curbing irregular land usage, scaling down fiscal stimuli and raising the official reserve requirement ratio.

China’s GDP expanded 9.6 percent year-over-year in the second quarter, down from 9.8 percent in the first quarter. Quarter-over-quarter GDP growth was down to an estimated 2.8 percent (annual rate). Although it’s still too early to tell whether China can achieve a soft landing, there are definite signs of slowdown. Fixed investment in urban areas has decelerated, growing 30 percent year-over-year for the first eight months of 2004, down from 47.8 percent in the first quarter. Industrial production growth eased to 15.9 percent year-over-year in August from 19.4 percent in March.

Meanwhile, retail sales increased 13.1 percent year-over-year in August, following 13.2 percent in July, 13.9 percent in June and 17.8 percent in May. However, the high retail growth in May was distorted by the unusually low figure in the same month last year due to the severe SARS outbreak. So in general, consumption appears not to have responded as much to efforts to slow the economy. Foreign demand for Chinese goods has also picked up as a result of export expansion. Since May, China’s trade balance has turned to surplus after the first four months of deficits in 2004 (Chart 1).

Chart 1

The developments in the past few months have shed some light on the major concerns about the global impact of a Chinese slowdown. These concerns have concentrated on the possible drop in global commodity prices, the negative influences on foreign exports to China and world financial market stability.

The influence of the Chinese slowdown on commodity prices has been measured so far. Take steel as an example. Compared with a year ago, Chinese domestic steel prices increased 17.1 percent in August following 16.2 percent in July, although they were down from 18.5 percent in June, which in turn was down from 21.1 percent in May. On the world market, as of August 2004, the nonfuel primary commodity price index has come down from its recent peak but has not seen any drastic drop (Chart 2). The index that includes both fuel and nonfuel commodities is still up, mostly due to oil price increases.

Chart 2

Chinese imports surged 50 percent year-over-year in June before easing to 34 percent in July and 35 percent in August. General imports may slow in the coming months as tightening efforts impact demand. But imports for processing are poised to increase quickly as exports pick up speed. So the overall impact on foreign economies, and particularly on China’s neighbors who are part of the same supply chain for exporting to the West, may be limited.

Worries about China-induced financial market turmoil, both regionally and globally, have not materialized. One specific concern that can be put to rest is whether China will reduce its holdings of U.S. Treasury securities. So far, as China’s foreign currency reserves have been climbing steadily, so has its holding of U.S. treasury securities (Chart 3).

Chart 3

Whether China can eventually achieve a gradual, orderly slowdown remains to be seen, particularly in the face of rising inflation. The Chinese consumer price index increased 5.3 percent year-over-year in both July and August (Chart 4), continuing the recent upward trend. Month-over-month, it showed an increase of 0.7 percent in August, following decreases of 0.2 percent in July, 0.7 percent in June and 0.1 percent in May. The producer price index increased 6.8 percent in August, up from 6.4 percent in both June and July.

Chart 4

The People’s Bank of China has refrained from raising the benchmark one-year lending rate. A rate hike before the effects of the measures already taken can play out fully may cause unwarranted further tightening, thus increasing the possibility of a hard landing. However, if the inflation situation worsens, the People’s Bank of China may have no other choice.

Dong Fu is an assistant economist and Jahyeong Koo is an economist at the Federal Reserve Bank of Dallas.

SUGGESTED CITATION:
Fu, Dong and Jahyeong Koo (2004), "China's Economy Is Cooling," Federal Reserve Bank of Dallas Expand Your Insight, October 4, http://www.dallasfed.org/eyi/global/0410china.html.