World's Economic future tied to China

July 3, 2008

World's economic future tied to China's inflation woes

NEW YORK - WILL Beijing be able to engineer a soft landing for its racing economy, or will the world be hit with a triple-whammy of weakness in the United States, Europe and China?

The globalisation of China's economy has not just seen Chinese products enter billions of homes around the world, it has also linked the world's fortunes to China's economic future.

China's exports, clocked at about US$1.2 billion (S$1.64 billion) last year, make up almost 9 per cent of the world's total. But its imports, at US$900 billion, are also helping to keep other economies afloat.

If the dip comes, how big will it be? China's government clearly realises that its economy is in danger of overheating, but it has been reluctant to take severe measures to put the brakes on growth. A moderate but steady increase in the value of the yuan may help to erode China's trade surpluses. Interest rates, however, have yet to rise substantially.

Part of the reason for this expediency is probably political. China's central bank is not really independent of the political leadership, so even the double-digit inflation predicted by some economists may not lead to tighter credit, especially during the showcase of the Olympics this summer. And if the bank is already reticent, recent events may have exacerbated the situation.

'We think official concern for growth will keep the authorities from taking aggressive action to slow inflation,' wrote Mr Tim Condon, the chief economist for Asia at ING Barings, in his forecast last month. 'Raising interest rates would be seen as almost unpatriotic in the light of the massive reconstruction needs from the earthquake.'

Pressure on wages could drive domestic prices even higher in the second half of this year, says Credit Suisse economist Dong Tao.

For the past couple of years, China has been seeking to reduce its economic growth from 11 per cent or 12 per cent annually to a figure more like 8 per cent or 9 per cent. Even that change has been difficult to achieve.

If inflation keeps increasing and growth does not ease soon, a soft landing - a slight slowdown in economic activity without slipping into a recession - could be impossible.

So far, inflation in China has been partially driven by domestic demand and partially by increases in global commodity prices. Yet, pressure on wages could drive domestic prices even higher in the second half of this year, said Mr Dong Tao, the chief economist for Non-Japan Asia at Credit Suisse.

'If we're seeing wage increases, we're seeing price adjustments,' he said. 'If these factors lead to the second wave of inflation, then we might have a much bigger problem. Then the government might launch a much more aggressive credit policy than what we've seen now.'

Mr Tao said he saw two scenarios for the Chinese economy. In one, lower demand for China's exports would cause a slight slowdown in the country, taking some pressure off prices and allowing the economy to catch its breath. China's growth rate would drop by a couple of percentage points, but it would be enough to stem inflation.

In the other scenario, high inflation would lead to an aggressive action by the government in the form of higher interest rates and perhaps faster appreciation in the yuan as well. The booming Chinese property market would take a hit and domestic consumption would suffer - as would demand for Chinese products from the rest of the world.

That would be an important development for the global economy. A drop in China's annual growth rate from 12 per cent to, say, 4 per cent would cost the global economy about US$280 billion in lost output - almost exactly the same as a drop from a 3 per cent growth to 1 per cent in the US.
INTERNATIONAL HERALD TRIBUNE