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Mixed Data Shows China’s Stimulus Working, but More May be Needed

By , Money Morning •

By Jason Simpkins
Managing Editor
Money Morning

Fixed asset investment in China soared in the first two months of the year, as Beijing's $585 billion stimulus plan took hold. But more stimulus may be needed, as China's all-important export sector continues to sag and declines in consumer prices have raised concerns about deflation.

Fixed-asset investment in China climbed an estimated 26.5% year-over-year in the first two months of 2009, the National Bureau of Statistics said yesterday (Wednesday). Railroad investment - a key fixture in the $585 billion stimulus plan Beijing unveiled in November - led the way, more than tripling in the months of January and February.

New domestic currency lending has increased as well, surging to 1.6 trillion yuan in January.

"The economic figures are stabilizing and recovering, which demonstrates that the policies have begun to show an impact," said Chinese Bank Governor Zhou Xiaochuan.

Of course, not all of the figures coming out of China have been positive. After falling 17.5% in January, exports plunged 25.7% last month to $64.9 billion.  Imports fell 24.1% in February to $60 billion.

"This is an ugly number," Merrill Lynch & Co. Inc. (MER) economists T.J. Bond and Ting Lu said in a note to clients. "The export slowdown has finally come home to China."

China's exports rose throughout 2008 despite the economic decay taking place throughout the Western world. Exports actually jumped 4.3% year-over-year in the fourth quarter, even as the U.S. economy contracted by 6.2%.

Another growing problem for China is deflation, signs of which began emerging last month. Consumer prices in China fell 1.6% in February - the first drop since 2002.

Chinese officials downplayed the declines, pointing out that they were largely the result of a high base of comparison. Last February, consumer price inflation was running at 8.7% as the prices of food and fuel soared.

"The price falls are mainly caused by declines in international commodity prices; they do not mean that the Chinese economy is contracting," Su Ning, a deputy central bank governor, told reporters during the annual meeting of parliament.

Indeed, evidence that inflation - which climbed into double-digits last year - has subsided is a welcome relief for authorities who, once upon a time, were worried the Chinese economy was overheating. However, deflation could become a serious problem for China if it instills expectations of further price declines and consumers start to defer purchases at a time when the country is trying desperately to kick start domestic consumption.

"I think [the CPI drop] is the first sign of deflation," Qing Wang, China economist for Morgan Stanley (MS) in Hong Kong, told Reuters. "We expect an additional policy response, mainly to prevent deflationary expectations from getting entrenched."

Qing believes the People's Bank of China will cut interest rates by 27 basis points by the end of the month, Xinhua reported.

With about $2 trillion in foreign exchange reserves and a debt-to-GDP ratio of just 18%, speculation that China will expand its stimulus package continues to swirl as well. Stocks around the world rallied last week when reports surfaced the Chinese Premier Wen Jiabao would announce further economic stimulus measures at his address to the National People's Congress.

Premier Wen did not announce an expansion of the stimulus plan, but did affirm his 8% growth target for the nation's economy. Wen also said the government would increase its spending on social programs by 17.6% to about $6.4 billion.

Frank Gong, chief China economist at JP Morgan Chase & Co. (JPM), believes that increasing government spending will be the best way to bolster the economy, as investment accounts for 43% of China's economic growth, versus just 7% for exports.

"They should do more, spend more money to build national pensions, health care insurance and unemployment benefits," Gong told BusinessWeek.

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