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UPDATED: April 24, 2007 NO.17 APR.26, 2007
In Full Flight
The ballooning Chinese economy and its strong first-quarter performance are encouraging, but making economists vaguely uneasy

Trade frictions with China's major trading partners will be inevitable if the trade surplus continues to be this high. To ease these trading partners' concerns, Tao argues that they need to be aware of the structural dilemmas China faces.

"First of all, I think a lot of trade surplus is structural," Tao said. "China has evolved into a world factory, and a bulk of production capacity has been allocated to China, so that it is unavoidable that China will have a large surplus which would not be affected by regulative measures."

Tao explained that an increasing amount of production has moved to emerging markets like China and India. China is a major goods provider, but not a service provider, which is why there is a huge surplus in China's current account, he said.

Tao pointed out that all forward-looking indicators in March-new orders, new export orders, import index and backlog of orders-saw increases of about 4 percentage points from the previous month, the strongest jump since 2005. The relatively late occurrence of the Chinese Lunar New Year (falling in mid-February this year instead of late January) probably added a little upward bias to the March data, he said. "But by all means, this set of data is strong, indicating that economic activities are likely to accelerate further from the robust figures recorded in the first two months of this year," Tao argued.

To even out the balance of payments, the Chinese Government is determined to import more from major trading partners holding trade deficits with China, namely the United States and the European Union. In early April, the Chinese Ministry of Commerce announced that it would import more mechanical and electrical machinery from abroad. At the same time, it has either reduced or cancelled tax rebates on certain Chinese exports such as iron and steel.

"China's market has grown large and its demand is high, meaning China is not only a major production factory, but also a big market," said Tao.

Adding the renminbi (RMB) appreciation factor, Tao believes China's imports will also boom. Tao projected that the RMB and dollar exchange rate will probably stand at 7.33 with the Chinese currency continuing to appreciate to 6.9 in exchange with the dollar.

Loan growth, inflation, speculation worries

To achieve "sound and fast" economic development is a target set in the 2006 government work report. However, real actions won't come as easily as words. Tao discussed three major problems that should be carefully watched by the government authorities.

First of all, bank loan growth is too fast, said Tao. Rapid loan growth helps fuel excessive liquidity, which holds hidden troubles for China's financial and capital markets. Excessive liquidity can cause rampant price fluctuations and market bubbles. If excessive liquidity is suddenly squeezed out, the stock market will be hit and the overall economy will suffer, he said.

"We expect the lending behavior of Chinese banks to change," Tao said, adding that the recent loan boom doesn't jive with the long-term objective of bank reform in China.

Secondly, Tao fears possible inflation if the CPI keeps climbing over the warning limit. "It is rebounding and is likely to exceed 3 percent by the middle of this year," Tao estimated. At present, not only is fiscal inflation picking up steam, but also asset inflation is growing even faster. "We actually see the bank depository rate heading into negative, which prompts the banks to look for higher investment opportunities," said Tao.

Tao also worries that increasing speculation in the Chinese stock market will generate more bubbles. The Chinese stock is traded two times more in price/earnings ratio than the global average of 17 times. This distortion is likely triggered by speculative capital. Tao argues that if the stock market is not handled properly, it can harm China's economic stability.

But luckily, the decision-makers have already attached due importance to speculation, and the government is expected to attempt to squeeze out the speculative bubble in the stock market.

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