Continued strengthening of domestic demand is expected to offset weaker exports due to the slowdown of US and European economies, and keeps China's economic growth on a steady upward trend. With the pick up inflation, consumers would cut short their wait for better bargains and step up spending. Moreover, a return to mild inflation would lower the real return on bank deposits, and encourage consumers to save less and spend more. Meanwhile, the opening of China's services sectors after the country's entry to the World Trade Organization would attract massive inflows of foreign direct investment. To prepare for increased foreign competition, Chinese companies would also step up investment to boost their competitiveness. Supported by stronger consumer spending and increasing private investment, real GDP growth is projected to rise from 7.1% in 1999 to 8.0% and 8.3% in 2000 and 2001 respectively, reversing its downward trend since 1993.

Thanks to rapid expansion of exports and recovery of consumer spending, China's real GDP growth rose to 8.2% in the first half of 2000, compared to 6.9% in the second half of 1999. With robust overseas demand due to booming global economy, exports surged by 38% year-on-year in the first half. Following a 30% pay hike for state-sector workers last September and the doubling of government spending on social welfare early this year, consumers have become more willing to spend. Retail sales value therefore swelled by 10.1%, compared to 6.4% in the same period last year.

Looking ahead, the growth of exports is expected to slow to 21% in the second half and further to 15% in 2001. To contain rising inflation, US and European central banks have tightened their monetary policy over the past year. Given that the US market accounted for 41% of China's exports, a slowdown of US economic growth in the second half of 2000 as suggested by recent indicators would inevitably hit the demand for Chinese goods. The impact on exports would be even larger in 2001, when the economies of Euro Area, which absorb another 24% of China's exports, also begin to weaken. The slowdown of US and European economies would more than offset the increased demand for Chinese goods from the recovering Asian region.

Domestic demand is, however, expected to pick up more rapidly. With the easing of deflation as shown by the 0.1% increase in consumer prices in the first half of 2000, from a 1% decline in the second half of 1999, consumers would cut short their wait for better bargains and step up spending. A return to mild inflation would also lower the real return on bank deposits, which had already tumbled from 2.8% in December 1999 to 1.3% in June 2000, and encourage consumers to save less and spend more.

Meanwhile, investment is also expected to gain momentum after China's accession to the World Trade Organization (WTO) later this year or in early 2001. With more secured access of China-produced goods in overseas markets after the country's entry to the WTO, and given the country's abundant supply of low-cost land and skilled labor, more foreign producers would increase investment to set up production base in China. More importantly, the opening of China's services sectors including financial services and telecommunications to foreign firms would attract massive inflows of foreign direct investment (FDI). To prepare for increased foreign competition, Chinese companies would also step up investment to boost their competitiveness.

Although real GDP growth may slow to 7.8% in the second half of 2000 due to weaker exports, continued strengthening of domestic demand will more than offset the weaker exports and boost China's economy in 2001. Real GDP growth is, therefore, projected to rise from 7.1% in 1999 to 8.0% and 8.3% in 2000 and 2001 respectively, reversing its downward trend since 1993. As continued recovery of economic growth will help to clear surplus production capacity, consumer price inflation is likely to rise from -1.4% in 1999 to 0.5% and 2% in 2000 and 2001 respectively.

Supported by massive capital inflows and sizeable trade surplus, China's balance of payments is likely to remain favorable in 2000 and 2001. Apart from larger inflows of FDI after China's entry to the WTO, the inflow of portfolio investment will also rebound as Chinese companies have resumed overseas listings. Meanwhile, the trade surplus will remain sizeable despite continued rapid increase in imports due to stronger domestic demand and soaring world oil prices. Given the favorable balance-of-payments position, China is under no pressure to devalue its currency. The Renminbi may, in fact, strengthen should the central bank allow a wider fluctuating band for its exchange rate.

Jason Kwok
North Asia Chief Economist

Joe Lo
Senior Economist

Ellen Cheuk
Economist

Alice Chan
Senior Information Officer

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