Strong growth won't change China policy

SINGAPORE, Jan. 25 (UPI) -- Investors can stop worrying about a boom-bust in China. China's economy shrugged off hard-landing worries that dampened sentiment for most of 2004, posting 9.5 percent GDP growth for the full year. Yet, analysts are confident that the surprising strong growth will not prompt a change in monetary policy.

"We do not expect the authorities to respond to the faster pace with a tightening of monetary conditions," said Desmond Supple, economist at Barclays Capital.

Growth accelerated to 9.4 percent in the fourth quarter from 9.1 percent in the third. Chinese officials were quoted saying that growth would have been even higher had it not been for the government's control measures.

"The record December trade surplus was a harbinger of an upside fourth quarter GDP growth surprise. Stronger external demand and consumption demand offset a slowdown in investment spending growth -- the essence of the soft landing," Tim Condon, economist at ING pointed. China's exports rose 35 percent to a record $593.4 billion last year.

"Several factors leave us relatively relaxed about the pick-up in the fourth quarter growth," Supple said, "Firstly, on a seasonally adjusted and annualized basis, the fourth quarter GDP growth was far more modest, rising 7.7 percent versus 8.2 percent in the third quarter. While this measure of GDP growth is highly volatile, the fourth quarter nonetheless represents the slowest growth rate since the third quarter of 2003."

"A second factor that provides us with a degree of comfort in believing that the GDP data release will be neutral for economic policy formation is that while headline growth remains brisk, the components of growth attest to the unfolding success of the authorities in terms of reining-in the 2002-04 credit bubble," he added.

Crucially, fixed asset investment (FAI) is continuing to decelerate. Full-year FAI growth measured 25.8 percent, with a 21.3 percent year on year rise in December, well below the 28.4 percent recorded in 2003. In real terms, the slowdown is even quicker, Supple added.

Investment growth in the 20-30 percent range is too high to be sustained indefinitely, but not high enough to trip overheating warning lights, added Condon.

"We have always attributed the investment surge to the relaxation of credit controls in early 2003 to cushion the impact of SARS and we now consider that the authorities have successfully brought investment under control. Investors can stop worrying about the last boom-bust and start worrying about the next one, which like the last one is likely to be triggered by a policy change. We expect signs of another investment boom would be met by administrative tightening," Condon predicted.

Inflation, the other overheating indicator, slowed to 3.9 percent for the full year helped by a slowdown to 2.4 percent in December from 2.8 percent in November. Food price inflation has been the main source of headline CPI though medical services prices inflation also contributed.

With slowing inflation, the growth-inflation trade off has turned more favourable for policy makers in China this year, Goldman Sachs analyst Hong Liang said.

"This implies no new administrative tightening nor interest rate hike will likely be introduced in the near term," she said, adding that the CPI should continue to soften in the coming months, partly owing to significant supply responses in areas where previous capacity constraints led to acute price pressures. Goldman is maintaining a 2.6 percent CPI forecast for 2005.

"Disinflation is continuing and we still expect the market to be surprised by the absence of inflation in China in 2005," Supple said.

Massive hot money inflows in the fourth quarter could be the biggest threat to price stability.

Condon estimates $55 billion on hot money inflows took place in the last quarter based on the difference between the $95 billion rise in foreign exchange reserves and the $28.1 billion trade surplus plus $11.9 billion of Foreign Direct Investment.

"Surging hot money inflows make inflation, not investment, the most likely next worry for policymakers. They heighten the need for exchange rate reform sooner rather than later," Condon said.