While economic activity in China has moderated in line with the global economy's slowdown, growth of exports and imports remains robust, according to the World Bank's latest China Quarterly Update.

The World Bank quarterly update provides an update on recent economic and social developments and policies in China, and present findings from ongoing World Bank work on China. The update is produced by a team from the Beijing Office with support from the China country team.

OVERVIEW

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 development take place as record balance of payment surpluses complicate monetary policy, but growth of monetary aggregates remains under control.

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.

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RECENT ECONOMIC DEVELOPMENTS

The global slowdown has started to affect China’s growth. High food and commodity prices keep inflation elevated, while record external surpluses challenge China’s monetary and exchange rate policy.

In line with slower growth elsewhere, China’s GDP growth moderated so far in 2008. Earlier this year, GDP growth for 2006 and 2007 was revised up, both by ½ percentage point, fully reflecting more rapid expansion of services. This brings revised GDP growth for 2007 as a whole to 11.9 percent, and points to even stronger economic growth than previously envisaged. Having peaked in the second quarter of 2007, GDP growth slowed to 10.6 percent in the first quarter of 2008, as the impact from a gradually weaker world economy was accentuated by the impact of the February snowstorms (Figure 1). Industrial production growth held up well in the second quarter, averaging almost 16 percent (yoy) in April-May, although the strong May data was flattered by a higher number of workdays than a year ago.

The moderation of growth in 2008 in part reflects less buoyant investment. Nominal urban fixed asset investment (FAI) grew over 25 percent (yoy) in the first 4 months, broadly unchanged from the 2007 average. However, adjusted for the rising pace of increases in prices of investment goods, the expansion of real urban FAI slowed from 21 percent in 2007 to 16 percent in the first five months of 2008 (yoy) (Figure 2). The investment slowdown so far in 2008 was most pronounced in industry, where sales prospects are most exposed to the fortunes of the global economy. In the service sector investment also slowed, but in agriculture it surged, buoyed by strong agricultural income and higher food prices. To date, higher inflation has had little effect on retail sales. As nominal retail sales speeded up in line with inflation, real retail sales continued to grow at around 13 percent (yoy) so far in 2008.

inflating import values. Export growth held up well so far in 2008 in US$ terms. However, adjusted for rising export price increases export growth declined from an average of 18 percent in 2007 to an estimated 12 percent in the first 5 months of 2008 (yoy) as global growth is slowing. (Figure 3). Import prices accelerated even more—they rose by 18 percent in US$ terms and 8 percent in RMB terms (yoy) in the first four months, boosted by surging raw material and energy prices. In fact, although import growth in US$ terms accelerated since the fall of 2007, real import growth softened.

The large decline in the terms of trade reduced China’s trade surplus from a year ago in the first five months. In constant prices, the contribution of trade to growth was 1.5 percentage points in the first quarter of 2008 and even somewhat higher in April-May— much lower than for most of 2006 and 2007 but still positive (Figure 4). ...

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