The Olympics were a glorious showcase opportunity for China, but there are signs of an economic hangover.
Masters of the Universe now speak Mandarin
The Olympics were a glorious opportunity for China to showcase its prowess to the world, but after the party there are signs of an economic hangover looming, adding to global financial and recession misery. This centres on what direction to take for the tightly controlled Chinese currency, the yuan, and the implications for the wider Chinese economy and a world economy now threatened with global recession. After letting the yuan rise at an accelerated 12 per cent annualised pace in the first half of this year, the Bank of China has guided the spot yuan 0.6 per cent lower in the last few weeks. With China's top leadership shifting its tight policy emphasis from the "Two Prevents" (inflation and overheating) to a more flexible balance between inflation and downside growth risks, yuan forwards have tumbled sharply, taking the central bank's signals to mean Beijing will slam the brakes on the yuan's rise in order to cushion exporters. Already there are indications of a slowdown in China's record economic growth levels of about 11 per cent annually, to 9 per cent in the three months to September. According to Chinese officials involved in currency-policy decisions, the yuan will certainly rise at a slower pace in the second half of this year than during the first half, but the State Council has not made any decisions to alter this year's full-year target of roughly 10 per cent nominal appreciation against the dollar, which would imply a yuan around 6.60 to the dollar by year end. There is some speculation that the central bank is working off a medium-term target to return the yuan to roughly 5.8 yuan to the dollar - the currency's level prior to the 1993 devaluation - by the end of 2010 if China's economy sustains healthy rates of growth. Internal Bank of China forecasts see GDP decelerating to between 9.3 and 9.5 per cent next year, 8.5 and 8.8 per cent in 2010, and 8.3 and 8.5 per cent in 2011-2012, with the yuan pushing as far as 5.5 to the dollar by 2012, towards the end of premier Wen Jiabao's second five-year term. The sharply deteriorating global financial and credit markets have started to release their negative impact on China's economy, and even these state forecasts are on the optimistic side now. The yuan's slowdown since mid-July could be the result of several factors such as slower export growth. The commerce minister Chen Deming strongly lobbied the State Council in July to assist traditional low-end light manufacturers in coastal provinces that are being hammered by slowing overseas markets, rising labour and energy costs, and a higher yuan. The commerce ministry does not oppose the appreciation of the yuan, but it does want to stabilise the yuan's appreciation expectations, and argues that the currency's faster rise in the first half of the year has not proven to be a meaningful tool in curbing imported inflation. No one is considering reversing the yuan's uptrend in order to support struggling exporters at the bottom of the value chain. The Chinese government has already admitted that half the country's toy makers had gone out of business. Further targeted tax relief, rather than foreign-exchange policy, will be used instead. The second factor has been a stronger dollar. The dollar has strengthened over the past month, and the dollar constitutes roughly 30 per cent of the currency basket the Bank of China uses as a guide to day-to-day foreign-exchange management. The yuan has spurted 3 per cent higher against the euro since mid-July to its strongest point since February, and is now up for the year. Then there were the Olympics. Stability was the name of the game, and the vice premier Wang Qishan made it clear that all monetary and fiscal policies would remain stable during the duration of the Olympics. With the games over, the Chinese leadership is now faced with different considerations. One of these is deterring hot money. According to internal government estimates, about US$87.5 billion (Dh321bn) in short-term speculative inflows have flooded China in the first half of this year, disguised as foreign direct investment, short-term foreign-exchange loans, foreign-exchange swaps, falsified trade settlements and other channels. The government estimates about $700bn in hot money is now sloshing around the economy, and that could be destabilising if it rushes out, which is why Beijing is tightening capital controls. What the yuan's recent moves do not indicate is any shift by Beijing towards more significant loosening of policy as the economy slows. There is plenty of data showing that industrial production, real fixed-asset investment and net exports are cooling off. This has been sufficient to trigger some targeted policies to offer selective relief, but with plenty of pipeline inflation still in the system, China is hardly moving to pump up an economy it has been fighting to cool from overheated levels. The Bank of China, for example, has slightly eased credit curbs on commercial banks, raising lending quotas this year by 200bn yuan to 3.8 trillion yuan, as well as cutting interest rates twice and reducing banks' required reserves. This will still leave this year's lending quotas much tighter than last year's. The measure is intended to answer complaints from small and medium-sized private enterprises that the credit curbs have been disproportionately impacting them at the expense of large state enterprises with plenty of financing alternatives to bank loans. In the near-term, China's post-Olympics data is likely to offer plenty of fodder to those expecting a hard landing: industrial production figures will look soft, given the scope of Olympics-related shutdowns to improve air quality and a summer power crunch that impacted aluminium and metals producers. But China's top leaders are firm believers that the economy is heading for a soft landing, and measures like targeted export-tax relief, less-tight credit policies and a slower yuan are meant to indicate that they will be there to cushion the downside should more meaningful growth risks materialise. These augur well for the Gulf countries, whose economies are fast becoming intertwined with the fate of China's economy as it strives to take up the slack from falling western demand. Despite lower growth rates, it behoves us all to watch closely what happens in China, for after the recent fiasco in the financial markets, China is taking over the title of "masters of the universe" from Wall Street investment bankers. Dr Mohamed A Ramady, a former banker, is a visiting associate professor in the finance and economics department at King Fahd University of Petroleum and Minerals, in Dhahran, Saudi Arabia