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The Chinese Paradox

By Yiannis G. Mostrous on April 12, 2012

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Earlier this month, Chinese Premier Wen Jiabao noted in a series of speeches that although the current state of the Chinese economy is good, domestic demand is not as strong as it should be.

Most analysts share this mixed assessment. China’s exports for March were up a solid 8.9 percent year over year to USD166 billion, as developed economies gradually improved, especially in the US. The Middle Kingdom’s exports should stabilize at current levels, as the US economy continues to recover.

At the same time, imports grew 5.3 percent YoY in March, a relatively strong showing compared to the almost 8 percent growth earlier in the year. If import numbers remain at these levels, the trend will serve as one more indication that domestic demand in China is weakening.

That said, for the entire first quarter exports rose by 7.6 percent, while imports rose by 6.9 percent YoY. These are disappointing performances compared to the 14 percent growth of exports and 20 percent growth of imports in the fourth quarter of 2011, but they’re still solid numbers overall. Furthermore, the country’s trade surplus continued its descent, registering at USD670 million for the quarter.

China’s exports of electronic products and machinery equipment were among the strongest, rising by 9 percent YoY and 12.4 percent YoY, respectively. Labor-intensive exports were weaker, with clothing up 3.9 percent, textiles 1.4 percent and shoes 2.8 percent.

These numbers are the result of weaker demand from abroad, especially Europe. But keep in mind, China’s leaders also have been steadily trying to shift the economy away from labor industries and up the value chain.

The government knows that domestic demand needs a boost, which means more accommodative policies are likely in coming months. The focus is bound to be on low-end consumers, although the economy as a whole will be helped. These measures will be aggressive but nothing like the two-year emergency stimulus package unleashed by the government in 2009 in the midst of the Global Financial Crisis.

The main challenge for the Chinese government will be to provide the necessary conditions for a pickup in demand. Although banks have been more willing to lend, insufficient demand still plagues a variety of economic sectors. Investors should not be surprised if monetary policy becomes even more flexible in the coming months.

The Chinese economy should be able to grow its gross domestic product (GDP) by about 8 percent this year, while the government presses on with structural changes. The markets will be glad to see the government moving ahead with long overdue price hikes in gasoline and with higher power tariffs. Also on the table: tax code reform and the potential for lower corporate taxes.

Although headline CPI inflation rebounded to 3.6 percent YoY in March from 3.2 percent YoY in February, it remained below the 4 percent threshold that usually makes the Chinese government uneasy. Inflation should remain relatively contained this year, especially if the current growth cycle is as weak as the market currently believes.

As I’ve been noting since last November, GDP growth in China will be lower in 2012. Nevertheless, the expected growth rate this year of 8 percent is solid, especially if it can be achieved by boosting domestic demand in the world’s second-largest economy.

The bottom line for investors: fears over Chinese stocks are largely unfounded. These concerns are overblown and an investment opportunity could be emerging.

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