Analysis: Is China overheating again?

SINGAPORE, March 16 (UPI) -- China's fixed asset investment rose sharply in the first two months of 2005, while industrial output growth posted a stunning reacceleration. Both data are pointing the Chinese economy could be overheating once again.

"Needless to say, the reacceleration of industrial activity is a major setback, suggesting a resurgence of Chinese industrial activity that is nearly as torrid as that of a year ago. Moreover, this year's vigour is hardly an 'easy comparison,' since it is measured relative to the overheated pace of a year ago. No matter how you cut it, China is hot," said Stephen Roach, chief economist at Morgan Stanley.

On Tuesday, the National Bureau of Statistics announced China's industrial production rose 16.9 percent in the first two months of the year marking more robust industrial activity than at the end of last year. The two main industries that contributed to the rapid growth were the smelting and pressing of ferrous metals (up 26.8 percent) and electronics (up 19.1 percent).

On Wednesday, the bureau reported fixed-asset investment had risen 24.5 percent in the same period over Jan-Feb 2004 to $50.9 billion, compared with a 21.3 percent increase in December. The boom was driven by local governments, whose investments were up 26 percent while investment from the central government was up only 13.9 percent. In 2004, fixed asset investment grew 25.8 percent and the National People's Congress has just announced a target of 16 percent for this year.

"The latest investment data in themselves do not make the case that the investment boom has returned, but are enough to keep policymakers and investors on guard," says Tim Condon, economist at ING Financial Markets.

"So much for the measured slowdown: a Chinese economy that appeared to be on a path of steady deceleration over the course of 2004 has suddenly re-accelerated in early 2005," adds Roach.

At the recent National People's Congress, Prime Minister Wen Jiabao stressed the government could not relax efforts to slow economic growth and singled out fixed asset investment as the main threat. He warned that over-excessive fixed asset investment could lead to further "overstretching" of the economy.

"Investment growth in fixed assets may very likely pick up again as coal, electricity, oil and transportation are still in short supply," Wen said.

Some economists are pointing that investors should not get unduly concerned as the January-February data are usually distorted by the Chinese New year holiday.

Ben Simpfendorfer, an economist at JP Morgan, pointed to investors in a research noted that first quarter fixed investment data are unreliable, accounting for just 12 percent of "reported" annual spending.

However, Condon said that although investment has a tendency to surge at the beginning of the year and slow thereafter, "we're sceptical that the slowdown will bring it to the premier's 16 percent target."

ING is forecasting fixed investment growth of 20 percent this year.

With higher than expected inflation, industrial production and investment in the first two months of the year, the debate over the need to tighten investment policy further is likely to rekindle.

"The January-February data indicated that China was still overheating

seriously and at the just-concluded National People's Congress, delegates

expressed serious concerns about the property bubble," notes Andy Xie, economist at Morgan Stanley.

The Chinese government appears to be under pressure to adopt further tightening measures and another rate hike and anti-property speculation measures could be introduced soon, Xie said.

"If inflation crosses the central bank's 4 percent line in the sand we believe it would trigger an interest rate hike," Condon added.

However, the central bank may be reluctant to hike rates ahead of anticipated currency adjustment as higher rates would fuel capital inflows, some economists noted.

"Further monetary tightening could well pose a major problem for an economy with a fixed exchange rate -- further fueling speculative capital inflows into Chinese financial markets. That will undoubtedly lead to an intensification of the debate over the Chinese currency regime," Roach said.