No cooling China's economic engine

By Zhou Jiangong

SHANGHAI - The worst snowstorms in 50 years that devastated central and east China before the Spring Festival or lunar new year may have slowed the country's economic growth sufficiently for the government to ease macroeconomic controls targeting overheating, argue some analysts.

Past experience, however, particularly after the acute respiratory syndrome (SARS) outbreak in early 2003, suggests the economy will tend to grow faster in the aftermath of the storms. We might therefore expect Beijing to maintain its controls as the snowstorms will not help rein in excess liquidity or reduce inflationary pressures.

The winter weather paralyzed transport, disrupted power supplies and prevented millions of rural migrant workers from heading home to share the Spring Festival holiday with their families. They also helped the stock markets continue declines that have brought benchmark indices down 22% this year.

The dismal weather also had an international impact, helping to drive coal prices to a historical high on the world market. As Chinese factories shut down amid power outages, the price of some commodities such as zinc and copper soared to recent highs. Interruption of transport between the central and coastal regions and even between some coastal provinces also affected the supply chain of the world manufacturing system.

The biggest concern for economic decision-makers in Beijing is the impact the disruptions will have on inflation. Added to strong demand for food and consumer goods during the Spring Festival, they could drive the consumer price index in January up as high as 10%, some analysts estimate. Shenyin Wanguo Securities has projected a rise of 6.8% in January, 0.3 point higher than in December, compared with an 11-year peak of 6.9% in November.

Further clouding the future is the risk of a global economic slowdown caused by a possible American recession, which could significantly curb China's exports this year. The external environment for the country's economic development could therefore be tough. Under such circumstances, economic growth definitely will slow dramatically if China continues to tighten its monetary policy. Thus the call by some economists for the government to loosen monetary policy.

China began to tighten monetary policy from the beginning of this year following a decision by the policy-making Central Economic Work Conference in late December, ending a decade-old "expansionary" approach.

Gross domestic product (GDP) growth for January is forecast to be slower due to seasonal factors and the effect of the snowstorms. The World Bank has adjusted its projection for China's 2008 GDP growth down to 9.6% from 10.8%. It changed its outlook for inflation up to 4.6% from 3.8%.

Natural disasters frequently bring shocks to the economy. In 1998, devastating floods on the Yangtze River coincided with the Asian financial crisis, tending to slow down the Chinese economy. To counter the negative impact on exports, the government began to adopt expansionary fiscal and monetary policies to boost investment and domestic consumption so as to sustain high-speed growth.

The aftermath of the outbreak of the severe SARS epidemic in 2003 may be more relevant to the current situation. When the epidemic broke out, the economy was at the upward stage of the cycle and concern was raised of an economic slowdown. Yet shortly after the outbreak, pent-up demand erupted and since then double-digit annual growth has been sustained through to the end of 2007.

That may encourage Beijing to keep alert for a possible early post-blizzards rebound in investment that could drive the economy back to the perennially overheating state the government has been working very hard to cool.

Furthermore, the chief target of China's economic policy is to keep inflation at bay. Senior officials at the People's Bank of China, the country's central bank, have publicly said the tightening monetary policy would continue.

The National Development and Reform Commission, which oversees economic and industry policies, has concluded that the snowstorms will not have any significant impact on the fundamentals of the economy.

Already, as a semblance of normality returns, Beijing is allocating funds for reconstruction plans. The cash will go on infrastructure such as roads, railways and the power grid. Plants will resume production and coal mining will pick up. Rural migrant workers will return to coastal export-oriented factories. The economic engine of China will soon be roaring again.

Beijing still has to grapple with excess liquidity. An expansionary US monetary policy will likely lead to more money being parked in China given that it is tightening its monetary policy, which includes raising interest rates. Higher benchmark rates will lure more money into China as investors gamble on profiting from higher returns and currency appreciation.

As China's exchange rate regime is still rigid, a tightening monetary policy is largely self-defeating since the government has to issue more money to buy inflowing foreign currency and keep the exchange rate within the targeted fluctuating band.

Therefore, excess liquidity and high inflation are still a threat. Effectively, the country's monetary policy is in a Catch-22 position: high inflation requires higher interest rates, yet these will generate more liquidity, which may add to upward pressure on prices.

Some analysts fear the risk of an overtight monetary policy if pursued amid a concurrent global slowdown. A bunch of government think-tanks and investment banks have already lowered projections for China's GDP growth rate this year to as low as 8%. The World Bank's most recent forecast of 9.6% compares with growth of 11.4% in 2007, the fifth consecutive year of double-digit growth in output.

Nevertheless, the post-winter reconstruction and investment, added to the momentum of domestic consumption, will leave China's economy well placed to offset any slowdown in exports.

Zhou Jiangong writes analyses on China's economy, finance and international affairs. Based in Shanghai, he is now editor of www.chinastakes.com, an English-language financial review of China.