Free Chinese Lesson - China's GDP surges by 11.3%

WORLD / Wall Street Journal Exclusive

China's GDP surges by 11.3%
By ANDREW BROWNE (WSJ)
Updated: 2006-07-19 09:13

http://online.wsj.com/public/article/SB115324732620910038-kfKa7AOPwCydhGbXE
puDG5FHX_c_20060725.html?mod=regionallinks

BEIJING -- A second-quarter acceleration of China's already-booming
economy underscores the mounting danger of runaway growth fueled by huge
trade surpluses, and it creates a number of thorny policy dilemmas for
China's leaders.

The National Bureau of Statistics said yesterday that the economy
expanded at an annual rate of 11.3% in the second quarter compared with
the same period last year -- a full percentage point faster than in the
first quarter.

The second-quarter growth -- the fastest in any quarter in more than a
decade -- came despite official efforts to slow the pace by curbing
investment, which has exploded because of the cash generated by booming
exports. The annual rate of growth in the first half of 2006 was 10.9%.

The danger is that excessive investment will spawn overcapacity, leading
to falling profits and bankruptcies. That, in turn, could devastate
Chinese banks and cause the economy to stall -- a jolt that would be
widely felt. The effect of a Chinese slowdown would be magnified if, as
many economists expect, U.S. economic growth slows this year as
interest-rate increases start to bite.

For Chinese leaders trying to contain excessive investment, the country's
currency poses a major dilemma. U.S. officials and others have pushed
Beijing to let the yuan appreciate faster -- an action that could curb
exports of Chinese goods by making them more expensive in dollar terms.
China's main problem is "the trade surplus, and behind the surplus it's
the currency," says Hong Liang, China economist for Goldman Sachs.

Beijing has been reluctant to allow any significant strengthening of the
yuan. Rather, it appears determined to drive ahead with a strategy to
cool growth by cutting investment. The next step, many economists
believe, will be an increase in bank lending rates, the second this year.

That policy will test Beijing's resolve to rein in local governments,
whose taste for extravagant construction projects is helping to drive the
investment boom. It also will pit the central bank against powerful
state-owned commercial banks that provide the money for much of that
investment.

The root of China's imbalances is the money flowing in from export
earnings. June's trade surplus, a record $14.5 billion, sent the total
for the first half to $61.45 billion -- 54% bigger than in the
year-earlier period. By year end, China will likely have foreign-exchange
reserves of more than $1 trillion, the largest stash in the world.

As dollars flood into China, they are bought by the central bank in
return for yuan, a process that keeps the value of its currency stable
but floods local banks with cash. Big lenders such as Bank of China and
Industrial & Commercial Bank of China keep lending those funds -- the
loans are the source of most of their profits.

In the first half of 2006, China's fixed-asset investment in such things
as roads and factories surged 30% from a year earlier, yesterday's
figures showed. Industrial output in June was up 20% from a year earlier,
compared with 18% growth in May, while retail sales for June surged 14%.
Inflation -- a looming concern as the economy adds froth -- also is
starting to creep higher. The consumer-price index increased 1.5% in June
after rising 1.4% in May.

In announcing yesterday's data, Zheng Jingping, spokesman for the
statistics bureau, characterized growth as "fast and stable."
Nevertheless, he said, investment in fixed assets was "excessive" and the
supply of credit "over-scaled."

Even if Beijing overcomes resistance from its local governments and
profit-driven banks, a strategy of curbing investment could actually
exacerbate the trade problem, many economists say. If the curbs damp
China's demand for goods such as steel and construction cranes, imports
of those products would dry up. At the same time, excess Chinese goods
would pour into overseas markets, widening its surplus. This is what
happened after authorities clamped down to fight overheating in 2003.

Chinese authorities have resisted letting the yuan appreciate to combat
excessive growth because they fear a rapid strengthening of the currency
could spawn bankruptcies by damaging exporters. Some Chinese farmers,
too, might face ruin if a stronger yuan encouraged demand for
foreign-grown produce by making imports less expensive. The yuan has
strengthened only about 1.4% against the dollar since it was revalued by
2.1% one year ago. One dollar now fetches about eight yuan.

The alternative to a significant appreciation of the yuan, in recent
months, has been hastily prepared measures intended to reduce investment
by curbing bank lending. In April, the central bank raised benchmark
one-year bank lending rates by 0.27 percentage point.

There are signs such measures are beginning to have some effect. In June,
lending was up 14% from a year earlier, slightly less than May's 15% rise.

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