China’s economic growth has moderated to a more sustainable pace. In line with slower global growth, activity decelerated so far in 2008. Adjusted for price rises, growth of real exports and imports has decelerated but remains robust. Sharply higher import prices are inflating import values, bringing down China’s trade surplus, even as the contribution of net trade to growth remains positive. The growth moderation in part reflects less buoyant investment, but China’s domestic economy is holding up well.
Headline inflation is receding even as non-food price pressures emerge. The food price increases are starting to fade out of the consumer price data. Some spill over is taking place of the higher food prices into wages and some other prices, while new impact from recent industrial commodity and oil price hikes is in the pipeline. Nonetheless, generalized spillover to consumer prices has remained limited and headline consumer price inflation should recede gradually. These price developments take place as record balance of payment surpluses complicate monetary policy, but growth of monetary aggregates remains under control.Amidst weaker and uncertain global prospects, China’s growth will be supported by strong international competitiveness and a robust domestic economy. Global growth is on course to slow further and commodity price driven inflation has become a complicating factor everywhere. These developments imply considerably more international uncertainty and risks. Nonetheless, China’s exports will continue to be supported by China’s strong international competitiveness. Domestically, while the human tragedy caused by the earth quake has been tremendous, the macroeconomic impact is likely to be modest. We expect China’s GDP growth to moderate to a solid 9.8 percent in 2008 (the upward revision to our forecast largely reflects revised GDP data showing stronger service sector growth). On current growth forecasts, there is no need to ease the overall macroeconomic stance, although global uncertainty calls for vigilance and flexibility. In the case of a more serious slowdown than currently envisaged a fiscal easing would be well suited, but macroeconomic management demands good coordination between fiscal and monetary policy. Containing the spill over of raw material price pressures and inflation expectations requires relatively tight monetary policy. China’s current macroeconomic situation calls for continuing with strengthening the (trade weighted) effective exchange rate. Bringing prices of fuel closer to levels that reflect the scarcity of energy is important for rebalancing and to reduce distortions.
Reducing China’s very large external surpluses remains a key policy challenge. The current account surplus is still responsible for the majority of the external surplus. Reducing it requires a set of structural policies to rebalance the overall pattern of growth, a key government objective on which progress seems to be limited so far. Speculative inflows seem to have increased recently. If policymakers consider such inflows to be a large problem they can be discouraged by tightening controls on capital inflows and policies that effectively change exchange rate expectations.