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Fearing slowdown, China could veer into overheating

Analysis

The only thing to fear in the slowing Chinese economy may be excessive fear of a slowdown itself.

Some worrying is warranted. But rushing into a fiscal stimulus, a hot topic of late, could make the economy a bubbling cauldron of unstable growth and inflation, its biggest problems just a few months ago.

“It's very easy for them to relax policy more than they should,” said Ben Simpfendorfer, an economist with Royal Bank of Scotland in Hong Kong. “All of a sudden you could see a return of overheating risks.”

China's economy has decelerated markedly, the latest evidence coming this week in surveys that showed its manufacturing sector was shrinking for the first time in three years.

Disruptions from the Olympics, when scores of factories were shuttered to clean the air, likely exaggerated the slump but the trend of a slowing economy is clear enough. China's annual growth was 10.1% in the second quarter, well off last year's scorching 11.9% pace.

That has prompted calls for government spending to prop up momentum. Speculation has run high that Beijing might craft a hefty stimulus package, with Chinese media reports talking about plans for tax cuts, academics recommending pump-priming and exporters pleading for support.

Resisting such appeals is made difficult by the fact that China could easily afford a cash splurge.

The overall national budget turned to a surplus of 173.9 billion yuan, or 0.7% of GDP, last year. Total government revenue grew 30.5% from a year earlier in the first seven months of 2008, outpacing expenditure.

“The fiscal situation overall is pretty solid and has been improving for a number of years,” said Grace Ng, an economist with J.P. Morgan in Hong Kong.

Nevertheless, China's pockets are not bottomless and hasty spending now would empty them too soon when many forecasters think growth could slow further over the next two years.

“A stimulus package now would, more importantly, waste precious fiscal ammunition that may well be needed for the future,” Stephen Green, a Standard Chartered economist in Shanghai, said in a recent note.

“It is not a cost-free policy choice. Given the abandon with which the idea will likely be thrown around over the next few months, we would advise caution,” he wrote.

China entered 2008 with an economic policy guided by what it called the “two prevents”: prevent overheating and prevent inflation.

Although there has been no declaration of a policy shift, worries about overheating have all but disappeared from official statements, replaced instead by vows to maintain rapid growth.

Beijing has, however, not dropped its warnings about inflation. Cheaper food has allowed headline consumer inflation to recede from a 12-year high of 8.7% in February to 6.3% in July, but price pressures have spread more broadly to other goods.

And while exports have dipped as the global economy wobbles, capital investment has proved as resilient as China's dominance in its national sport of table tennis.

Mixed signals should stay Beijing's hand on fiscal stimulus.

“The government will probably want to observe a little bit more and wait to see more concrete signs of the direction and the momentum of the economy,” Ng said.

To be sure, most of the policies being floated under the guise of a fiscal stimulus are relatively modest.

There has been much talk about reforming China's value-added tax regime to allow corporations to write off spending on capital goods, which economists reckon could save businesses about 200 billion yuan, or nearly 1% of GDP.

Tax cuts, though, deliver less of a boost than direct spending, Ting Lu, a Merrill Lynch economist, said.

What is more, the VAT reform has been discussed for many years and probably will not be introduced until January, making it more a gradual change than a sudden stimulus.

China also has lots of monetary policy scope to breathe more life into the economy. For nearly one year, the government has sharply limited bank lending to tame credit growth. It has already increased loan caps by 5% and could go further.

Throw in more money for affordable housing and higher income-tax thresholds, and a picture emerges of stimulus that, so far at least, has been quite sober.

“It's not just releasing the purse strings. It's tweaking with one eye to developmental objectives,” Simpfendorfer said. “China is least in need of a fiscal package, especially relative to the developed economies.” (Reuters)

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