China: Not so fragile

Although most developed and developing economies came out of recession during the course of last year, most recoveries are expected to be slow and fragile in nature.

The situation with China is, however, different to most other economies. While the Chinese economy grew in each of the first three quarters of 2009, data recently released stated that the Chinese economy returned to double-digit growth in the final quarter of last year as it grew by 10.7% year-on-year. Although this latest growth figure was below expectations, it still represented the fastest rate for two years and a sharp increase on the 9.1% achieved in the third quarter.

The latest growth figure for the fourth quarter took China’s growth for 2009 as a whole to 8.7%, comfortably above the official Government target of 8%. With Japan’s economy expected to continue to struggle in the short term, many analysts believe that China is poised to become the world’s second largest economy later this year.

The Chinese economy has benefited from decisive and swift action from their Central Bank. In 2008, the Chinese Central Bank aggressively loosened monetary policy and alongside other significant fiscal stimulus packages, there was a boom in both new bank lending and money creation in 2009.

Government subsidies have contributed to a sharp rise in consumer spending and this led to China overtaking the US last year as the biggest car market. However, it is important to note that these figures include government spending as well as households and it is the former that is driving the current high growth rate.

As we move through 2010, economic growth in China is expected to remain strong but there are a few potential headwinds that could cause challenges. The most obvious challenge is how to affect a timely and smooth withdrawal of the fiscal stimulus. Owing to the sheer scale of the stimulus, this is not an insignificant challenge and the government will look to withdraw it in such a way that the recovery is not derailed.

We have in fact already recently seen moves to marginally tighten monetary policy with banks being told to raise their reserve ratios. However, the Chinese government and central bank are concerned about inflation and excessive liquidity as well as ensuring that the economy is not growing too quickly above the target rate.

Looking at inflation, as well as the announcement of the strong fourth quarter growth, after having fallen for much of the year consumer prices were reported to have risen by 1.9% year-on-year in December from an increase of 0.6% in November. This was the sharpest monthly rise in inflation since early-2008 and although the overall level has not yet reached a point that would cause serious concern, it has led to an increased chance of a rise in interest rates sooner rather than later.

The Chinese currency also continues to be highly topical with the renminbi being effectively pegged to the US dollar since mid-2008. External pressures on China to allow their currency to strengthen are growing significantly and while the government continues to resist such moves, it is expected that there will at some point be a move to allow some strengthening.

Richard Wallis is head of research and investment at Origen