China’s Economic Slowdown Continues

China’s inflation accelerated due to climbing food prices, with the Consumer Price Index (CPI) rising 2.7 percent year on year in June, up from the 2.1 percent registered in May (see Chart 1). Although inflation is expected to remain tame in the coming months in the absence of an economic recovery, the central bank is more worried about long-term inflationary risks, which could complicate policy, especially as property prices keep escalating. Meanwhile, the Producer Price Index (PPI) fell 2.7 percent, marking the 16th straight month the index has declined (see Chart 2). Factory-gate prices extended its longest streak in a decade amid slowing economic growth and lower commodity costs. Overall, the lowest first-half inflation since the financial crisis in 2009 and prolonged factory-gate deflation underscoring weaker demand put the government at risk of missing its annual growth target for the first time since 1998.

Manufacturing slips

China’s official Purchasing Managers’ Index (PMI) for the manu-facturing sector fell to 50.1 in June, down from 50.8 in May (see Chart 3). A PMI reading above 50 indicates an expansion in manufacturing activity from the previous month, whereas a reading below 50 indicates contraction. While the PMI stayed above 50 for the ninth consecutive month, major PMI sub-indexes all declined in June, indicating downward pressure on the economy. Slowing growth in China’s factory sector, as well as tighter monetary conditions after a squeeze in the interbank market could further constrain the Chinese economy in the second half of the year.

Slower GDP growth

China’s annual economic growth slowed to 7.5 percent in the second quarter, down 0.2 percentage points from the previous quarter and officially marking two consecutive quarters of slowing GDP growth. While Beijing hopes 2013 growth can hit 7.5 percent - a considerably faster pace than other major economies - it would mark the slowest pace in 23 years for China. Newly appointed leaders President Xi Jinping and Premier Li Keqiang have shown a greater tolerance for slower economic expansion than their predecessors, focusing on reforms rather than short-term stimulus. According to government economists, Beijing would tolerate quarterly growth slipping as far as 7 percent before taking measures to lift the economy and avoid widespread job losses that could threaten social stability.

Trade slump deepens

While retail sales growth edged up to 13.3 percent in June, they have risen just 12.7 percent year on year thus far this year, down from 14.4 percent in the same period in 2012 (see Chart 4). China’s exports and imports both unexpectedly declined in June, a sign that weakness in global and domestic demand will intensify the slowdown in the world’s second-biggest economy. Imports declined 0.7 percent after a 0.3-percent drop in May to reach $147.2 billion (see Chart 5). Following May’s collapse in export gains after a crackdown on fake invoices that inflated data, exports fell by 3.1 percent in June from a year earlier, the first decline since January 2012, to reach $174.3 billion (see Chart 6). China’s exports to the United States and European Union fell by 5.4 percent and 8.3 percent respectively, putting the government’s trade growth target of 8 percent for 2013 in jeopardy.