Tuesday, August 19, 2008

China's Domestic Boom

Even while growth in Europe and Japan has stalled, there are some mayor global economies which haven't stalled-namely the so-called BRIC, which is to say Brazil, Russia, India and China. Of particular interest is China, not only because its economy is much larger than the others, but because particularly Brazil and Russia depend on China. Brazil and Russia are both large commodity exporters and as the commodity price boom ultimately depends on Chinese demand, this means that their prospects depend on China.

And so far, there is no evidence of any significant slowdown in the Chinese economy. While industrial production numbers for July, and likely even more so August, will be depressed by factory closings related to the Olympic Games, growth has hold up very well despite the downturn in America and slowdown in the EU and Japan. Indeed, as is illustrated in the figure below from The Economist, growth in domestic demand (particularly retail sales) have in fact accelerated significantly even while export growth has plummeted.

Not only has export growth decelerated sharply in yuan terms, but the trade surplus is declining in yuan terms even as nominal GDP growth has been roughly 20%, causing net exports to plummet as a percentage of GDP. But because of the higher growth in domestic demand, real GDP growth has fallen only slightly.

This shift in the focus of Chinese producers from exports to domestic demand is exactly what not only the Chinese economy, but the world economy as a whole need, and there are good reasons to believe it could continue.

Notw however how I wrote "could continue" and not "will continue". The reason for this is that there are some worrisome signs that Chinese officials do not understand the need for China to focus on boosting domestic demand, as the yuan's appreciation versus the U.S. dollar have stalled during the latest month, and as export tax rebates have increased for some exporters. While the stall in appreciation versus the U.S. dollar is not necessarily as worrisome as it seems in light of the dollar's rally (the yuan's overall trade weighted value has in fact because of this increased faster than earlier in the year) and while it is certainly understandable that Chinese officials are worried about job losses in export related industries, these moves are still not a good thing. It would be much better if they for example reduced taxes on domestic economic activities in order to create jobs there.

Despite this policy mistake, China still has a good chance of decoupling and making it with only a milder slowdown. Something which would also be positive for commodities and therefore also Brazil and Russia.


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