Government measures to curb potential overheating continue in China

In mid 2010, China became the world's second largest economy, surpassing Japan and now second only to the United States according to figures released in August by National Bureau of Statistics. China's nominal GDP was valued at US$ 1.33 trillion, ahead of the US$ 1.28 trillion assessment of Japan's economy. China's real GDP grew 10.3% year-on-year in Q2 of 2010, down slightly on the 11.9% recorded in the first quarter, and reflecting the governments intention to avoid overheated economic growth.

This slowdown is likely to extend over the rest of the year as the government steers monetary and fiscal policy back to normal after the record credit surge designed to counter the global crisis. The government feared that overly rapid growth might inflate a housing bubble and compromise its environmental goals. It has therefore been gradually drawing back the enormous stimulus applied to the economy since late 2008, while also clamping down on property-market speculation and the expansion of polluting and energy-intensive industries.

In the first seven months of this year, the value of Chinas imports and exports jumped 40.9% year-on-year: to US$ 1.62 trillion. China exported US$ 850.49 billion worth of goods, up 35.6% year-on-year but, despite the rebound in exports witnessed since December 2009, in absolute terms they remain a long way below the levels seen in July 2008. We will need to see a full 12 months trend of significant reversal before we can definitely conclude that exports have recovered.

Chinas government recently highlighted six key industries in which overcapacity was a problem: namely, iron and steel, cement, flat glass, coal chemical, poly-silicon and wind power equipment. To enable growth to be steadily maintained the government has taken a number of measures to control industrial overcapacity, which has a strong impact on companies at every stage of the supply chain and on end-users.

In the first half of 2010, the steel industry faced high production costs due to the failure to negotiate lower iron ore contract prices, coupled with massive oversupply. The steel market depends heavily on the performance of the international market, and in particular the stimulation of consumer demand. Troubles in the eurozone and the slow yet steady recovery in North America indicate that a strong revival in the Chinese flat steel industry is unlikely to occur until 2011.

The gradual recovery of the global economy and national policies supporting the textile and garment industry have seen China's clothing exports make a steady rise, but the textile and garment industry is still facing problems. External demand is still weak, trade protectionism is growing, and export costs are high, as regulation of the cotton market this year has led to higher overhead for China's domestic enterprises. As a result, textile and garment export competitiveness has been weakened.

But, besides these problematic sectors, there are also healthy industries such as the pharmaceuticals sector, which has recorded steady growth thanks to the stimulus of new medical system reform launched by the government in 2009. Chinas pharmaceutical industry is among the top five drug markets in the world in terms of overall size, with a large pool of highly skilled, low-cost scientists and general labour. The reform of regulations on foreign direct investment [FDI] has seen pharmaceutical regulation in particular undergoing considerable change in recent years. Many processes have become increasingly aligned with international norms, making the operating environment increasingly transparent for outside investors. Multinational drugmakers have recognised the opportunities in China's fast growing pharmaceutical market and are keen to establish a significant long-term presence in China.

Government support for SMEs

China is increasing its financial support to small and medium-sized enterprises [SMEs] with preferential tax policies and easier funding channels. The government has extended to the end of 2010 the implementation period for allowing troubled SMEs to defer payment of social security or pay a lower premium rate. Aside from this, the government also wants small banks to give more financial support to SMEs.

Over the past six months there has been no obvious increase in late payments. Overdue payments have been due mainly to the morality issue so called Moral Hazard - rather than to financial difficulty.

2010 will be a crucial but complicated year for China's economy as the country continues to combat the after effects of the global financial crisis while maintaining a stable and comparatively fast economic growth, and adjusting its economic structure. The government is aware of the risks of rising inflation and overheating asset bubbles, and has therefore tightened its monetary policy, albeit moderately: with a credit supply of Yuan 7.5 trillion in 2010 down from Yuan 9.59 trillion lent by China banks throughout 2009 under a loose monetary policy. Slowing property prices, stress in the banking system, weaker global demand for Chinese exports, the formal ending of the Yuan/US$ peg, inflation and wage pressures all point to slower growth.