China slows down just enough

August 2, 2010

Evidence that China is slowing sounds like fodder for double-dip doom-mongers. But investors have taken a fall in the manufacturing index to a 17-month low in their stride. With further cooling measures now looking unnecessary, they are probably right to be sanguine.

Continued Chinese expansion is a critical support for the troubled global recovery, but some deceleration is helpful. Gross domestic product rose by 11.9 percent and 10.4 percent during the first and second quarters respectively, much higher than the official 8 percent growth target for 2010. That prompted Beijing to introduce a string of measures targeting the hot property market and credit growth, in turn prompting investors to fear that tougher intervention may be in prospect.

The latest data provides some reassurance that the current measures are working well enough. The official manufacturing index is down to 51.2 in July from 52.1 in June, but July figures are always lower than June figures. It’s not quite the slowdown it seems. On a seasonally adjusted basis, the July index even went up by 0.4 percentage points from June, according to Goldman Sachs. The figures are also distorted by July’s floods, with heavy rains hitting the industrial bases of southern and northeastern China hard, damaging roads and forcing factory closures.

Recent tightening measures have had an effect, in particular on the bubbly real estate sector. But activity is already recovering, driven by new public housing projects. Inventories of long steel products, typically used in construction, are falling and their prices are rebounding sharply. Finished goods and raw materials inventory is also low. Judging by hiring activity, Chinese industry does not envisage a nasty slowdown. Manufacturers continue to add new workers in anticipation that they may have to drum up production.

The situation is still finely balanced. For now, intervention seems to be producing the desired results, and it’s easy to see why investors pushed Chinese equities higher — in spite of having already rebounded strongly — on Aug 2. But the Chinese economy often goes through wild swings. It will take more than one month’s data to be certain of a soft economic landing.

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