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China balances growth and inflation
2008/10/07

By Wu Qi (China Features)

Seeing fully loaded trucks drive steadily away from the warehouse, Cheng Yongchang uttered a long sigh of relief. Despite dripping with sweat from the hot weather, the general manager of a South China toy producer would frequently feel waves of chills from a “winter of foreign trade.”

Small- and medium-sized enterprises (SMEs) in South China's Pearl River Delta, the world's workshop, are facing a critical period of trying to survive the current global economic slowdown. Cheng's plant, Long Run Industrial Co., Ltd., a Hong Kong-funded toy manufacturer with about 2,000 employees in Heyuan City, Guangdong Province, has managed to survive. However, nearly eight out of 10 of his toy exporting counterparts, largely small-sized and thus weak to resisting risks, had closed down.

“Higher costs for labor and materials at home, a stronger yuan and a stringent monetary policy have dampened our financial prospects," Cheng says. “This is the hardest year we've ever met.”

At the toy plant, raw materials have risen about 40 percent so far this year over the same period in 2007. Worker's monthly salaries had doubled to an average of 1,200 yuan (175 U.S. dollars) from 2004 when the plant went into operation. In addition, the appreciation of the RMB, China's currency, devoured 3 to 4 percent of its profits. The plant exported about 25 million yuan (about 3.65 million U.S. dollars) of toys last year, largely plastic toys for McDonald's and alloy car models to Germany.

“We managed to survive, thanks to our size and loyal customers,” Cheng says.

Toy makers are not the only businesses to have bad luck. Shoe makers and textile mills have suffered heavily as well in the Pearl River Delta.

Guangzhou Customs statistics showed that in the first half of this year, nearly one-half of shoe exporters became insolvent in the delta region. This left only 2,617 plants. In the first seven months, Guangdong garment exports were reduced 31 percent year on year, and the exports were valued at 13.3 billion U.S. dollars.

These businesses have one thing in common: labor intensive export-based processing businesses that earn trifling processing fees from foreign buyers. They accounted for 66 percent of export values in the province in the January to July period.

Nationwide, rising costs, the fallout from the U.S. sub-prime mortgage crisis, the appreciation of the RMB, and frequent natural disasters, such as February's snowstorms in the south and the May 12 earthquake in Sichuan Province had added more pressure to small- and medium-sized export companies, even dealing some with deadly blows.

STEADY AND FAST GROWTH

Because of these unfavorable elements, as well as macro-control measures, the Chinese economy has shown a steady slowdown from the previous red-hot growth and stepped into a stable "green-light zone."

Statistics show the Chinese economy grew 10.4 percent to 13.06 trillion yuan in the first half of this year, 1.8 percentage points lower than the same period of 2007. It slowed quarter by quarter, growing 11.3 percent in the fourth quarter last year, 10.6 percent in the first quarter this year and 10.1 percent in the second quarter.

The slowing GDP growth was yet 0.3 percentage points higher than the average of the past 30 years of the reform and opening up. It was also higher than the 8 percent target fixed by the government earlier this year to cool the breakneck growth.

“The output slowdown was a moderate correction from a high level," says Zhu Zhixin, vice minister of the State Development and Reform Commission (SDRC). "The national economy is heading in the direction expected by the macro-control policy."

China has undergone several major economic ups and downs since its reform started 30 years ago. Each was triggered by overheating, partly resulting from decentralization, pricing policy shifts or forex system reform.

Among ensuing macro controls, the one in the 1984-1986 period was given up halfway and that in the 1989-1990 period caused a hard landing. The macro control drive in the 1993-1996 period ended up with relatively serious deflation because no timely turnaround was achieved for a then tight monetary policy.

Since September 2007, the country's macro-economic operation had been in an overheated "yellow light zone" for four months running. In view of the situation, the government raised the notion of preventing economic growth shifting from fast growth to growing over-heatedly.

Following the country's macro-control measures, i.e. a tight monetary policy and prudent fiscal policy, the overheating risks that once threatened the economy had been pared. Three major drivers of growth -- investment, consumption and exports -- had maintained a good momentum, says Wang Yiming, a SDRC economist.

"The national economy is now on a normal track as overheating risks recede," says Fan Gang, a member of the Monetary Policy Committee under the People's Bank of China (PBOC), the country's central bank. “For a period of time to come, to ensure economic growth will become the top task of China.”

With on-going industrialization and urbanization, China's economy would remain robust and vigorous, as the need to narrow regional disparities would continue providing opportunity for growth, according to NBS spokesman Li Xiaochao.

Economists believed a 9 to 10 percent growth rate was most desirable for the economy, and the growth would slip from last year's 11.9 percent to stand at around 10 percent for 2008.

Though there were many problems and uncertain factors, such as persistent price rises, uncertainties in demand abroad, squeezed corporate profit margins, difficulty in ensuring energy and power supplies, and undue expansion of foreign exchange reserves, the fundamentals that had propped up economic growth had not changed; the Chinese economy would maintain steady and fast growth trend this year, NBS chief economist Yao Jingyuan says .

CURB INFLATION

With the tightening monetary policy, a core of macro-control measures, rising prices that loomed over the Chinese economy had slackened somewhat. The country's consumer price index (CPI), a main gauge of inflation, eased to 6.3 percent in July from 7.1 percent in June, 7.7 percent in May and a peak of 8.7 percent in February this year.

Over the past 30 years, China had experienced four major periods of inflation and one serious period of deflation. The highest CPI rise was 24.1 percent in 1994. The country's CPI had signaled a "yellow light" or cautionary period for nine months since September 2007, indicating lingering inflationary pressure.

All of past major inflations were triggered mainly by domestic factors only. But this time, most experts believed, the inflation was ignited by external factors and was cost-driven.

Price increases for oil and farm produce worldwide would likely continue and shore up China's inflation, as the reliance of the country's economy on the outside world was now more than 60 percent due to its 30 year opening-up period.

Meanwhile, agricultural product prices at home, which were buoyed by short supplies after the severe winter weather and the Sichuan earthquake, would linger at a high level.

The rapidly expanding foreign exchange reserves, which pushed up the central bank's passive money supply, would add to the inflationary pressure.

China's forex reserves, already the world's largest, stood at 1.81 trillion U.S. dollars through June. This included a 280.6 U.S. billion dollar increase in the past six months, an average monthly increment of 46.8 billion dollars.

Observers, however, warned of an influx of huge short-term speculative funds as the fast expansion was achieved in tandem with a slowdown in trade surplus growth.

The government was focusing on using tightening policies to fight inflation. To date, China had increased interest rates six times and the reserve requirement ratio 14 times since last year.

To ensure a steady and fast economic development, the PBOC says it would seek a balance between fighting inflation and boosting economic growth for the rest of the year.

Meanwhile, the central bank would make small changes to its monetary policy at a proper time in the second half, responding to the domestic challenges and uncertainties in the global economy.

The central bank would encourage financial institutions to increase credit supply to key industries and weak links, especially to small enterprises, and those concerning agriculture, farmers and rural areas.

It also urges tightened supervision on foreign exchange flows to prevent the risk of large amount of outflows.

In July, the State Administration of Foreign Exchange (SAFE) created a new system that enabled real-time monitoring of foreign exchange flows. The system is mainly an Internet-based data exchange mechanism among SAFE, banks, enterprises and accounting firms.

Economic planners would also exert themselves to increase supplies of necessities, closely track key prices and make price controls more effective, says Zhu Zhixin of the SDRC, the industrial watchdog.

RESTRUCTURING IN MIND

To find a balance between "keeping stable and the relative quick growth of the economy" and "curbing the surging rise of prices," a key point for China's macro control policies, analysts point out the volume-control effect of stringent monetary policy ought to continue; the economic structure needs to be further improved through prudent fiscal policy.

Other analysts foresee a loosening of the tight monetary policy to provide liquidity for enterprises, especially exporters squeezed by weakening demand, credit control and rising costs.

Citing pressures on some industries and enterprises as one of the major conflicts in the economy, Zhu points out : “It would take time for the latest supportive policies to show an effect and for companies to adjust.”

In face of the rigorous environment, enterprises largely were adjusting their product mix, improving management and elevating product added values to alleviate the operation predicament.

In an apparent move supporting industrial innovation, Chinese administrators raised the export tax rebate rate for some textiles and garments from 11 to 13percent in early August; some highly-polluting products, such as chemical- fiber cloth and viscose-staple fiber were ineligible for the higher export tax rebate.

The large number of SMEs in the Pearl River Delta region had closed some of their factories or suspended production for the time being, because the majority of the factories remained stuck in contract manufacturing, or OEM (overseas export manufacturing) for foreign buyers,” says Dong Xiaolin, a Guangdong University of Foreign Studies professor. “This was not much of an issue for most Guangdong manufacturers in the past when a large sales volume and depressed wages had combined to produce big profits.”

“But making money is no longer that simple now. Manufacturers need to move up the value-added chain.”

As for the toy producer Cheng Yongchang, he is ready to follow the tide. “We will keep exploring new customers, and new products such as vehicle spare parts and daily necessities. And we will use more automated facilities to replace manual work for higher efficiency.”

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