Is the Chinese economy on a recovery path?

Just how seriously should one take the reports which say that China?s economy is verging on a recovery up-tick?

Quite seriously really. At 7.9%, this year?s second quarter (Q2) year-to-year (y-o-y) rate of demand growth has already overhauled Q1?s 6.1% by 1.8%. Industrial output is looking up too: y-o-y output growth nudged 9.1% in Q2 for companies beyond a size. That was a full 4% above the 5.1% growth which was noted in Q1. So these indicators are ideally matched.

But there is a downside: exports have been sliding, along with falling external demand. They fell by 21.8% y-o-y over the first half of 2009. Imports returned the compliment: they too dived, by 25.4%, over that interval!

Still, there is a silver lining, which is that even the 21.4% decline in June exports denoted a 5% improvement over the numbers of May. Plus, imports too improved by 12%.

Indeed, consumer good sales increased 15.0% y-o-y over the first half of the year and lifted price-adjusted growth to 16.6%. And at least one major component of this demand, housing, cannot be imported. Rising 31.7% y-o-y, it underpinned overall rise in consumption spending. Thus the turnaround seems imminent and destined to be propelled by consumer spending and investment.

Yet, even this is not the right time to cheer, or rejoice at Beijing?s stated resolve to lift per capita rural and urban incomes by 15% and 8%, respectively. That said, the commerce ministry says that all efforts at priming domestic demand will get unstuck unless domestic demand takes up the slack released by (weakening) exports. The ministry?s August 12 statement said local demand cannot ?provide a full remedy for the sharp contraction in external demand??a conviction that is intact despite the $586 billion stimulus package and the 7.73 trillion yuan given out in in loans over January-August. Those loans did lift investment by 33.5% y-o-y over the first half of the year, and infrastructure outlays had risen by 57.4% y-o-y?but that simply means the ?contribution? of exports to growth has been negligible. Actually, 7.1% was the growth for the first half of the year, but exports fell by (-)2.1%?leaving domestic offtake to save the day by posting 3.8% (consumption) and 6.2% (investment) growth, respectively.

To the IMF, in particular, it all adds up to the manifestation of the clear and ever-present danger of China?s exit from the international locomotive shed. Accordingly the Fund has abandoned old prescriptions and now wants China to import for consumption, use less capital to produce, and also to raise revalue the renminbi. This all-new Fund policy package can be inspected in the officially reported version (dated July 23, 2009) of what transpired during the Article IV Consultations between the Fund and China.

Held after a 2-year hiatus, the Fund?s central preoccupation was to ensure that the renminbi did not remain underpriced compared to the economy?s rate of inflation (thus discouraging importers and helping exporters.) But the consultation report also admits that not all Fund directors agree on that?meaning, there are some who feel that renminbi?s value has ?a lesser role in rebalancing?. (The Fund?s reason for that cannot be faulted though; it has to do with the overheating-led acceleration in the yuan?s value. So, what could be a boon for China?s competitors fails to cheer simply because the currency is disallowed from rising.)

Of course the Fund seems also to be persuaded to try and rebalance the sources of demand. And that would need policies other than solely those which relate to the exchange rate. Yet, even those appear to be tailored to raise the cost of doing business.

Emphasised, therefore, have been social safety-nets as well as sectors! Once in place, they could ensure that markets reflect the true capital. That explains, too, why the Fund inveighed against China?s practice of putting a ceiling on bank deposit rates, thus putting a ceiling on the cost of interest of capital. The latter can however be lifted directly the ceiling gets withdrawn. In short, the Fund distrusts free lunches and feels that nothing should be cheapened, or made easily affordable. Indeed, it could be a serious, and embarrassing, issue for the Fund should China, one of its bigger principals, join up with some neighbours in order to create a mammoth free-trade-area (FTA).

Anyhow, all reports suggest that China has exited its introverted mould which, in turn, has aroused the expectation of 9% GDP growth in Q3. The only hurdle that stands in the way of a faster trade recovery is the slow convalescence of the world economy.

Recovery there would make all the difference, and it could perhaps even force foreign trade to retreat from centre-stage. A firm upturn would even render some of Asia?s economies (or groupings) attractive enough to be targeted by OECD investors as platforms for import-substitution. Greater intra-trade simply sharpens the focus of this vignette of a re-emergent Asia. It also underscores the region?s growing share of economic power. As for whether there is a possibility of the region decoupling from others, that raises certain serious issues.

The deepest issue is the question of just how strong already is the structure of intra-Asian trade, centered on a production platform. That would have important effects, in the sense that the PRC is crucial to the boosting of intra-, and inter-regional trade. (It is that role which has served to deepen the economic interdependence between China and the rest of Asia.)

Underlying this interdependence also is the structure of rising intra-Asian trade, centered on the people?s republic of China as a production platform. That has an important effect in the sense that China is crucial to the boosting of intra-, and inter-regional trade (a role that has deepened economic interdependence between China and the rest of Asia.)

Decoupling, its opposite, might be useful in insulating Asia from the periodic shocks that continue to assail developed market economies. It would also lower Asia?s vulnerability to the concentric shock-waves that radiate out of business fluctuations elsewhere?North America in particular. No wonder some Asian economies (and economic groupings) have become attractive enough to be the target of OECD investors. Meanwhile, greater intra-trade sharpens the focus on this vignette of a re-emergent Asia, plus underscores the region?s growing share of global economic power. As for decoupling, it is a bit too late in the day to contemplate that.

?The author is a fellow at the Maulana Abul Kalam Azad Institute of Asian Studies, Kolkata. These are his personal views