China's Economy Slows on Weaker Production, Olympics Closures

By Kevin Hamlin

Aug. 16 (Bloomberg) -- China's growth is cooling and may spur the government to ease lending restrictions, provide more export-tax rebates and stall yuan appreciation, analysts said after economic reports this week.

Industrial production grew in July at the weakest pace in 16 months amid faltering orders for Chinese exports. Consumer prices rose the least in 10 months, giving policy makers room to boost the economy without fueling inflation.

The slowdown in China, which powered almost 30 percent of the global expansion last year, may be exacerbated by factory closures aimed at cutting pollution during the Beijing Olympics, according to Goldman Sachs Group Inc. The central bank yesterday said it would ``fine-tune'' monetary policy as weaker overseas demand for the nation's goods poses risks to the economy.

``Concerns over China's export health will translate into a complete reversal of the current tightening policy,'' said Donald Straszheim, vice chairman of Newport Beach, California- based Roth Capital Partners. ``Maintaining economic growth is now number one.''

China's economy grew 10.1 percent in the second quarter, the fourth consecutive slowdown, prompting Communist Party leaders to put a bigger emphasis on maintaining growth and protecting jobs. Government statements in the past month have dropped references to a ``tight'' monetary policy.

`Quite Nervous'

``China needs much faster growth than an average Western country as it has to generate 10 million jobs a year,'' said Tao Dong, chief Asia economist at Credit Suisse Group AG in Hong Kong. ``Eight percent growth in China is equivalent to a recession. Below nine percent would make the authorities quite nervous.''

Economic statistics for July released in the past week showed a mixed picture. Exports rose, retail sales climbed the most since 1999 and spending on factories and property increased.

At the same time, weaker production growth foreshadowed softening demand for Chinese goods as the U.S., Japanese and European economies falter. A government-backed survey earlier this month showed export orders falling to a record, suggesting shipments may ease in coming months.

The People's Bank of China yesterday said demand from abroad ``will continue to weaken.'' The central bank has halted the yuan's appreciation, making exports more affordable to overseas buyers.

The yuan fell 0.2 percent to 6.8700 against the dollar today for a fourth weekly loss, the longest stretch since a peg to the U.S. currency was scrapped in 2005. The Chinese currency gained 6.6 percent in the first half, double the pace of a year earlier.

Olympic Closures

Factory closures and restrictions on construction, mining and motor vehicles to reduce pollution for the Olympics will also be a drag on growth in August and September, Goldman Sachs said in an August 8 report. Factories closed in Beijing and the surrounding areas account for 26 percent of China's economy, according to Goldman.

Inflation slowed to 6.3 percent in July, giving the government more leeway to promote growth. The government has already raised loan quotas for banks to help small and medium- sized businesses and increased tax rebates for exports of textiles and garments.

``Beijing wants her export sector to thrive,'' said Roth Capital's Straszheim. ``Since 2004 double-digit economic growth has been taken for granted.''

Policies to sustain growth in Asia's second-largest economy could put a floor under raw material prices, helping commodity- dependent countries from Australia to Brazil.

Fiscal `Firepower'

China has the funds to pay for pro-growth policies, according to Credit Suisse. The country has a budget surplus of 1.5 percent of gross domestic product and currency reserves equal to 45 percent of GDP.

``Without this firepower we would be very negative on both China and commodities,'' said Andrew Garthwaite, an economist at Credit Suisse in London.

China plans to spend 3.8 trillion yuan ($550 billion) on transportation and infrastructure in its five-year plan running through 2010 and this year is tripling annual spending on railways to 300 billion yuan.

``New policy measures to support growth could include further tax rebates for low-end exporters, an easing of lending quotas, slower yuan appreciation or even depreciation,'' said Glenn Maguire, chief Asia-Pacific economist at Societe Generale SA in Hong Kong. ``China is returning to the investment-heavy growth model we saw in 2003 and 2004.''

To contact the reporter on this story: Kevin Hamlin in Beijing on khamlin@bloomberg.net;