Tags: Jason Simpkins, Olympics

China's Economy Looks to Rebound After Lackluster Olympics

By , Money Morning •

By Jason Simpkins
Associate Editor

Despite a flood of investment leading up to the 2008 Olympic Games, economic conditions in China have been on the decline for the entire month of August, leading some analysts to warn of a post-Olympic slowdown. But the Chinese economy so far has proved resilient, and with policymakers in Beijing scrambling to ensure economic growth, it will likely escape a significant downturn.

The Shanghai Stock Exchange's Olympic event was diving. The Shanghai Composite Index dropped roughly 12% between the opening and closing ceremonies of the games. It's now down about 60% from its October high. The steep drop came as a harsh surprise to many Chinese investors who were expecting the Olympics to be a boon for the economy.

"Everybody said the market would turn [positive] in July before the Games, so we listened and stayed in it," one trader told the Los Angeles Times. "In July, they said that the market's spirit would return when the Olympics came. What spirit is that? Now we are all dead and have no spirit left in the market."

There is no single explanation for the index's decline, but it can mostly be attributed to a rash of data that suggests China's high-flying economy is beginning to wobble in line with a global downturn.

"Recent data suggested that the slowdown has taken a firmer hold of the economy and the Olympics may present some downside risks," Citibank economist Ken Peng said.

China's industrial output slowed to a 17-month low in July as weakening exports hit factory production across the nation. Industrial production grew by 14.7% in July, down 16% in June and 18% percent in July of last year, the National Bureau of Statistics reported.

"The deceleration in export growth was the main reason for the slowdown in industrial output," the bureau said, adding that export growth for the month was 26.9%, compared to 34.2% in July 2007.

Also, producer price pressures remain high even though consumer prices that climbed to a 12-year high of 8.7% in February receded to a 6.3% increase in July. Increased costs for labor, energy, and commodities caused producer prices to jump 10% from a year earlier in July - an indication that corporate profit margins are caught in a vice.

China's gross domestic product (GDP) growth now has decelerated for four consecutive quarters. China's GDP grew 10.1% in the second quarter, after expanding by 11.2% in the fourth quarter of 2007, and 10.6% in the first quarter of 2008.

GDP growth is expected to slow even further as economic conditions throughout the world continue to deteriorate. Standard Chartered Bank has said China's rate of growth will slow to 9.9% in 2008 and 8.6% in 2009. China's economy grew 11.9% in 2007. 

Those rates of growth may still sound impressive but a nation as large as China needs economic growth to come along much faster than its Western counterparts.

"China needs much faster growth than an average Western country as it has to generate 10 million jobs a year," Tao Dong, chief Asia economist at Credit Suisse Group AG (ADR: CS) told Bloomberg News. "Eight percent growth in China is equivalent to a recession. Below nine percent would make the authorities quite nervous."

Mingchun Sun, China economist at Lehman Bros. Holdings Inc. (LEH) says GDP for the second half of 2008 will slow to 8.7% in the second half of 2008, and just 8% for all of 2009.

"If growth goes lower than 8% the government will be very worried," says Sun, who sees only 2 million jobs being created. "This is important because unemployment is related to instability."

Central Bank Shifts its Stance

The government is already worried. But unlike U.S. policymakers, Chinese authorities actually have the firepower to fend off a protracted slowdown.

China has a budget surplus equivalent to 1.5% of its GDP and currency reserves equal to 45% of GDP, according to Credit Suisse. That gives policymakers ample resources to keep the economy churning at a double-digit pace. And the government seems fully intent on promoting growth, despite a possible resurgence in inflationary pressures.

"Concerns over China's export health will translate into a complete reversal of the current tightening of policy," Donald Straszheim, vice chairman of Roth Capital Partners LLC told Bloomberg. "Maintaining economic growth is now number one."

The People's Bank of China made that very clear in its second-quarter monetary report, which dropped any reference to monetary policy as "tight." Instead, the second quarter report stated the central bank would "make its top macroeconomic priorities maintaining stable and relatively fast economic growth."

Inflationary risks "can't be neglected," the report noted, but added that "external demand will continue to weaken, and the negative impact on exports, economic growth and employment will emerge further."

That's a subtle but significant shift from he previous report, released in May, which said the central bank would "place a higher priority on containing price rises and curbing inflation, and implement a tight monetary policy."

In July, the Bank of China followed through by raising lending quotas for national banks by 5% and regional lenders by 10%, potentially allowing banks to extend about $26.3 billion (180 billion yuan) in extra loans over the rest of 2008. Those limits previously had been put in place to crack down on excess liquidity flowing freely through the market.

There is also growing speculation that policymakers in Beijing are assembling a $58 billion (400 billion yuan) economic stimulus package. The package would be equivalent to 1%-1.5% of GDP and aimed at smaller businesses struggling with high material and energy costs, a strong yuan, and withering export demand.

"The top leadership is carefully considering an economic stimulus package," said Frank Gong, chief China economist at JP Morgan Chase & Co (JPM). "This will include tax cuts and measures to ‘stabilize domestic capital markets' and support ‘healthy development of the housing market'."

A Rebound on the Way

Fixed asset investment is one of the areas already benefiting from the central bank's new direction. Total spending on mines, factories, and land between January to July shot up 27.3% from a year earlier, while central government investment accelerated 25.3% in the first seven months of the year. 

"The slight increase in fixed-asset investment (FAI) will help alleviate concerns about the magnitude of China's economic slowdown," said Jing Ulrich, chairman of China equities at J.P. Morgan Securities. "Targeted pro-growth policies, widely expected from the government in the second half, will have a countervailing positive impact on FAI."

The FAI news and anticipation of further pro-growth policies sent the Shanghai Stock Exchange sailing 7.6% on August 20 - the third largest single-day gain in all of 2008. However, the Shanghai composite index lost 45.38 points, or 1.85%, over the week, to finish at 2,405.23 points.

Of course, that doesn't mean the index will continue its decline. Investors continue to pressure Beijing to intervene, and with the central bank's renewed focus on promoting growth, intervention - through a stimulus package or otherwise - becomes more and more likely with each passing day.

"New policy measures to support growth could include further tax rebates for low-end exporters, an easing of lending quotas, slower yuan appreciation or even depreciation," Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA (ADR: SCGLY), told Bloomberg. "China is returning to the investment-heavy growth model we saw in 2003 and 2004."

Battered stock prices have also left some real bargains on the floor of the SSE, which could also restore investor confidence. At their October 2007 peak, shares on the Shanghai exchange were trading at prices nearly 53 times their annual earnings, according to Ulrich. Since then, the Price/Earnings ratio for Chinese stocks has fallen to about 18.

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