China's Export-oriented Economy Slows

With inflation and industrial activity significantly cooling in November, China is now taking measures to counter slowing economic growth.

Consumer inflation sharply cooled in China, with prices increasing by just 4.2 percent in November from a year ago according to the Consumer Price Index (CPI) (see Chart 1). While November's inflation rate was the lowest since September 2010, and well below the 5.5 percent rate recorded in October, it was still slightly above the government's annual target of 4 percent. Overall, tighter bank lending, higher interest rates, curbs on property speculation and slowing export growth all helped to ease inflation. Meanwhile, food prices, which account for nearly one third of the basket of goods used to calculate the CPI, increased by only 8.8 percent from a year earlier. Although a record high grain harvest this fall will further curb rising food prices in the months ahead, China's policymakers are unlikely to cease their close monitoring of inflationary movements.

Manufacturing contraction  

China's official Purchasing Managers' Index (PMI) for November fell into contractionary territory, sliding 1.4 points from October to a lower-than-expected 49.0 (see Chart 2). It was the first such contractionary reading since February 2009, when the Chinese economy was still feeling the effects of the global financial crisis. As a figure above 50 indicates expansion in manufacturing activity, while a figure below 50 indicates a contraction, it elevated concerns the world's second-largest economy is at risk of a hard landing. A deeper look into the low reading reveals a sharp decline in the new export orders index to 45.6 in November, down from 48.6 in October, indicating that depressed market conditions overseas, especially those in developed countries, are hurting global demand for Chinese goods.

China's export and import growth both slowed in November, providing further evidence that China's export-oriented economy remains heavily dependent on overseas demand for Chinese goods, particularly from Europe. Exports rose a mere 13.8 percent year-on-year to reach $174.46 billion, its lowest level in nine months and significantly slower than October's 15.9 percent increase (see Chart 3). It is anticipated China will focus on expanding trade with developing countries to find new sources of demand for Chinese goods. Import growth continued to outstrip export growth, increasing by 22.1 percent to $159.94 billion. However, import growth in China can largely be attributed to commodity purchases as Chinese firms seek to take advantage of low prices for raw materials such as copper and iron ore, rather than a real rise in goods consumption. Overall, China's trade surplus narrowed to $14.52 billion, down from October's $17.03 billion and essentially matching September's level. With potential home buyers still priced out of the real estate market, reduced overseas demand for Chinese goods, stagnant domestic consumption, and three consecutive quarters of slowing economic growth, China's policymakers face a tough road ahead in trying to orchestrate a soft landing for the Chinese economy

Shift in policy focus

At the end of November, most probably with advanced knowledge of the grim trade statistics for the month, the People's Bank of China (PBOC) unexpectedly decided to reverse its tightening policies, marking a major policy focus shift away from fighting inflation toward ensuring stable growth. On November 30, the PBOC announced it would cut the amount of money that banks need to hold in reserve, effectively releasing between $55 billion to $63 billion into the banking system, and the first such cut in the reserve requirement ratio (RRR) since 2008. The most immediate impact is to ease constraints on bank lending, which will help private business secure sound sources of funds to expand their operations and create new jobs. Furthermore, the move acts as a signal to markets and investors that China will do what is necessary to ensure stable economic growth amid deteriorating conditions both at home and abroad. This is even more important considering there will be a time lag between policy implementation and when its effects will permeate the real economy, meaning trade data and economic indicators will likely get worse before getting better. Moving forward, China will rely more on domestic demand growth, while continuing to carefully orchestrate the deceleration of fixed asset bubbles without sacrificing too much economic growth.