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Krishnan Thiagarajan

With efforts on to cool the over-heated Chinese economy, there can be a severe slowdown ahead. This will lead to commodity inventory liquidation and depress prices temporarily.

THE Chinese economy has been booming the past few years. This has led to a to a skyrocketing of its share in the world's total material consumption in 2003. For instance, it consumes 25 per cent of aluminium produced world-wide, 27 per cent of steel products, 30 per cent of iron ore, and coal respectively. Over the past year, China's copper imports have risen by 15 per cent, steel by 50 per cent, nickel by over 40 per cent and crude oil 36 per cent. In line with the rise in the country's material consumption, the global industrial commodity prices have also spiked. According to Mr Stephen Roach, Chief Economist, Morgan Stanley, "as growth in Chinese industrial output accelerated from 7 per cent in late 2001 to 19 per cent in early 2004, the Journal of Commerce Composite Index of Spot Industrial Material prices went from a deflationary -15 per cent YoY (year-on-year) to an inflationary 30 per cent YoY surge."

Gearing for a `soft landing'

Fearing the inflationary impact of the commodity price spiral and possible over-investment in the economy, the Chinese government has been desperately examining ways to `cool down' the system. In mid-April, the Chinese central bank raised the reserve requirement for banks by half a percentage point to 7.5 per cent. By end-April, the China Banking Regulatory Commission had asked banks to stop lending to steel, aluminium, cement, automobile industries and real-estate businesses. And the country's Vice-Premier stepped in to say that the Government would suspend projects in these areas and tighten approvals for new projects.

Clearly, there is a sense of desperation in the Chinese government circles to engineer a `soft landing' of the economy. This essentially means that China's GDP growth now pegged at 10 per cent has to be wound down to about 7 per cent, which will mean halving the rate of growth of industrial production and investment by the end of the year. According to China's National Bureau of Statistics, the country's industrial output in April rose by 19.1 per cent YoY, powered by a rapid growth in energy, raw materials and consumer goods. The rate of growth was down only marginally from 19.4 per cent recorded in March. A recent report by the Chinese central bank also shows that investment in three sectors — steel, aluminium and cement has surged by 97 per cent, 93 per cent and 122 per cent, respectively, in 2003.

Linkages to Asian economy

The soft-landing scenario assumes even greater significance, when placed in the context of the larger Asian economy (including Japan). For the past five years, there has been a high correlation between the Chinese import growth and Asia's export activity.

The surge in China's imports in 2003 has benefited the entire Asian economy. Over 30 per cent of Japan's total export growth was accounted for by exports to China in 2003, while Korea and Taiwan's share has been well over 35 per cent.

Obviously, if there is any hiccup in China's `soft-landing' exercise, it can take a heavy toll on the Asian economy.

Though early yet, this scenario cannot be ruled out at this stage. In this backdrop, it may be important to bear in mind the sagacious advice offered by Dr Marc Faber, the investment guru, in his column in November 2003.

In his view, the "Chinese appetite for resource play" has become well recognised by speculators. "As the Chinese economy is overheating and will, in my opinion, experience a severe slowdown in the near future, which will lead to commodity inventory liquidation and depress prices temporarily."

At this point, it is hard to say, if the recent decline in metal prices is just the preliminary leg of a prolonged correction or will it reverse direction soon. But for investors, it will definitely pay to stay clued on to the developments in the Chinese economy in the near future.

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