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Reliance On Construction Raises Risk

China Economy

China Economy

The National Bureau of Statistics of China released a 9.5% annual growth estimate for second quarter gross domestic product (GDP) today, meeting market expectations. This is only a mild slowdown from the 9.7% recorded in Q1, which indicates that further monetary tightening will be necessary to slow output growth to a level consistent with greater price stability.

A main driver of growth continues to be investment in real estate, which grew 32.9% year-on-year. This is higher than the overall 25.6% annual growth of fixed asset investment and underlines just how reliant China’s economic development is on the construction sector – a possible cause for trouble if the bubble bursts.

The major dilemma for Chinese policymakers is that inflation hit a three-year high of 6.4% in June. A large factor in this increase was a surge in the price of pork, China’s favourite meat, driven by a 0.5% fall in production evident in the latest GDP figures. A successful grain harvest should temper food prices, however. While rising prices are normal for a fast-growing emerging market, China has long enjoyed the deflationary impact on prices that it exported to Western economies and that allowed it to maintain low price growth during a period of swelling output.

A 13.7% annual increase in real incomes for rural workers shows that what appeared to be an inexhaustible reservoir of labourers from the countryside is beginning to ebb. Longer term, elevated global commodity prices and the clear trend of rising labour costs in the world’s workshop mean that the era of low inflation and low interest rates are probably coming to an end.

For now, the heavy reliance of Chinese growth on the super-sized construction sector raises the risk of a hard landing if the sector collapses. This is a danger not just to China but also to a world economy flirting with return to recession.