George Kerevan: Politicians rejig policies to avoid China crisis

HERE is a Chinese puzzle. First quarter growth in China, the world’s second biggest economy, was the slowest for three years, down to 8.1 per cent year-on-year.

This rang alarm bells in financial markets around the globe because China has been the engine of world growth since 2009. Yet paradoxically, other Chinese indicators were quite positive. In March, industrial output was up 11.9 per cent, while retail sales rose 15.2 per cent.

Explanation: the deceleration of the Chinese economy is the result of a deliberate policy by Beijing to curb a runaway property boom. The boom itself is the result of lax monetary policy back in 2009 when Beijing pumped some £400 billion of extra credit into the economy to offset the global recession. The worry is that having overdone the property boom, Beijing has overdone the correction.

Growth of 8.1 per cent sounds a lot to Europeans, but it is actually the bare minimum needed to create sufficient jobs for new entrants to China’s massive 800 million workforce. Worse, last month Beijing cut its growth forecast for this year to 7.5 per cent. On current form, it could be even lower. China’s legendary trade surplus has dwindled almost to nothing, as a result of a collapse of exports to ailing Europe.

Getting the economic sums wrong at this time would be very bad news for China’s rulers. The regime is suffering its worst political crisis since the demise of Chairman Mao, with the recent purge of the populist Bo Xilai and this week’s spectacular revelation that Bo’s wife has been arrested for allegedly murdering an expat British businessman.

This year has already seen a rash of strikes, involving factories owned by Chang’an Auto (one of China’s big four car makers), Sanyo Electric and Wuxi Little Swan (the world’s third biggest washing machine producer). The strike at Chang’an was particularly significant as the Chinese car industry is now consolidating after a massive expansion over the past decade based on domestic sales.

Beijing has been reticent about reversing the squeeze on credit, lest it spark inflation. However, with the economy slowing faster than expected, there are hints this policy is changing. During March, China’s banks – tightly directed by Beijing – issued the equivalent £100bn in new loans. Expectations of fresh monetary easing might explain why stocks rose on the Shanghai and Hong Kong markets yesterday, despite gloomy growth figures.

The falling Chinese trade surplus has also strengthened Beijing’s contention that the yuan is no longer undervalued compared to the dollar. Beijing allowed the yuan to appreciate against the dollar throughout 2011, to assuage protectionist sentiments in Congress. Expect that policy to go into reverse, boosting Chinese exports and – by year-end – growth.

Balancing act between US and Europe at IMF

THIS week the yield on Spanish ten-year sovereign bonds jumped to 5.9 per cent. The markets are starting to worry that the European Central Bank’s €1 trillion (£824 billion) injection of liquidity into the banking system has boomeranged. Why?

Weak Spanish banks borrowed cheap ECB money and used it to buy Spanish government debt, pushing down yields temporarily. Which means Spain’s banks have loaded up with assets that are now losing value – and now some share prices are suffering. Hence next Friday’s meeting of the International Monetary Fund (IMF) is of extra significance.

This summit is billed as a showdown to decide on increasing the IMF’s resources, the better to fund a bigger firewall for Spain and eurozone debtors. America is opposed to beefing up the IMF just to help rich Europe. IMF boss Christine Lagarde has been pouring French charm on troubled waters, claiming the agency needs a smaller injection than originally envisaged, thanks to the ECB intervention.

Largarde initially wanted an additional $500bn-$600bn (£315bn-£380bn). Realistically, she may get $400bn. Of that, $250bn will come from Europe, including nearly $30bn from Britain.

Problems? China and the emerging economies may offer extra cash, but only if they get more voting power. The markets may bet against a bigger IMF bailout fund and send Spanish (and Italian) bond yields soaring again. As Mao’s comrade Chou Enlai used to say: “We live in interesting times.”