KEY POINTS:
China is starting to gain control of its turbocharged economy, just as a United States slowdown raises the risks of doing so.
A narrowing trade surplus and declining money-supply growth are among the first signs that the world's fourth-largest economy is pulling back from its fastest expansion in 13 years.
The Government has raised interest rates six times in a year, restricted credit, frozen some prices and let the currency appreciate to damp growth and inflation.
The risk is that, with months of effort to cool off China finally taking hold when the US is already flirting with recession, both main engines driving the global economy may power down at the same time.
"As foreign demand deteriorates, China may overdo its tightening of policy and cause a sharp economic slowdown," says Frank Gong, Hong Kong-based chief China economist at JPMorgan.
"If the central bank raised interest rates too much, it would damp domestic demand and increase the danger of economic downturn."
China's economy expanded 11.5 per cent last year, according to a Government estimate, and it contributed 17 per cent to global growth, the same as the US.
With prices rising at the fastest pace in 11 years, the ruling Politburo and the central bank are trying to engineer a cooling of growth that doesn't also throw millions of China's 1.3 billion people out of work.
The tougher policies may be starting to pay off, data showed on January 11. Last month's trade surplus shrank to US$22.7 billion ($28.7 billion) from US$26.2 billion in November, and the broadest measure of money supply rose by the least in seven months.
"The efforts of the Chinese Government to slow the economy have long been half-hearted, but now they are looking more determined," says Phil Suttle, director of global macroeconomics at the Institute of International Finance in Washington.
"There is some evidence that this policy package is starting to have an effect."
Vice-Finance Minister Li Yong said in Beijing that China planned to better co-ordinate fiscal and monetary policies in 2008 to further cut the trade surplus and mop up excessive liquidity.
Yi Gang, a vice-governor of the People's Bank of China, said the central bank "will decisively fight against inflation and implement tight monetary policies".
Meanwhile, Goldman Sachs last week joined Morgan Stanley and Merrill Lynch in forecasting that the US, the world's biggest economy, would slip into recession this year for the first time since 2001 amid fallout from the sub-prime mortgage crisis.
This week, Goldman cut its 2008 growth forecast for China to 10 per cent from 10.3 per cent.
The two economies are closely linked. The US buys about 19 per cent of China's exports. A cooling US economy could magnify the impact of China's anti-inflation measures, says Qu Hongbin, chief China economist at HSBC Holdings in Hong Kong.
"A US recession would cause a major disruption to the Chinese economy," says Qu. "Aggressive tightening could prove overkill."
A 1 percentage point slowdown in the US would trim China's export growth by 4 percentage points and reduce GDP by 0.5 percentage points, according to Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong. Exports rose 21.7 per cent in December to US$114.4 billion.
Sun Mingchun, an economist at Lehman Brothers Holdings in Hong Kong, says China faces "heightened risks" because of its rapidly expanding manufacturing investment.
Its 24 per cent growth last year has created overcapacity and made the country vulnerable to a decline in exports and falling prices. Sun predicts economic growth will slide this year below 10 per cent for the first time since 2002 and inflation may fall below 3 per cent in the second half.
If China does want to reduce its reliance on exports, it needs to let the yuan gain faster so Chinese products are more expensive overseas, says Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington.
The current policy to restrain the currency forces the central bank to sell it to banks in return for foreign cash.
"The No 1 problem for China is controlling money supply in an environment where the currency is so undervalued," says Lardy, who has written several books on China. "If you want to have growth driven by domestic demand, rather than exports, you have to let the currency appreciate."
A simultaneous slowdown in the US and China would be bad news, says Nariman Behravesh, chief economist at Global Insight. China's trade with the rest of the world has been growing three times as fast as the global average since it joined the World Trade Organisation in 2001.
"A combination of US consumer spending and Chinese imports has pulled the world economy along," says Behravesh.
"The combination of a US recession and hard landing in China could push the global economy into recession."
Still, if Chinese leaders want to whip inflation, they may have no option but to keep raising interest rates and constraining credit and hope that any US downturn is short lived.
Consumer prices accelerated by 6.9 per cent in November from a year earlier, while producer prices rose at the fastest rate in more than two years.
"We expect rate hikes to continue, even with a global slowdown under way, to keep up with rising inflation," says Kathleen Stephansen, director of global economics at Credit Suisse Holdings in New York.
Binit Patel, an international economist at Goldman Sachs in London, says the likelihood of China suffering an abrupt reversal remains small.
While Goldman Sachs' financial-conditions index for the economy is now at its highest level since 2004, it still is "accommodative" and the economies of China's trading partners in Asia are still robust, he says.
"I'm not predicting an economic slowdown in China right now," US Treasury Secretary Henry Paulson said in an interview on Bloomberg Television.
"If that were to occur, that wouldn't be good for us."
A Chinese economy that has inflation under control would allow foreign central banks to try to boost their economies by cutting interest rates more deeply.
Prices of US imports from China increased just 0.1 per cent in December from a month earlier, the smallest gain since April and down from 0.4 per cent in August, the US Labour Department reported last week.
The dilemma, says HSBC's Qu, is that China can't afford to wait to discover the fate of the US economy.
Policymakers need to make a bet on whether domestic inflation or falling overseas demand is the biggest risk, he says.
"By the time the global picture becomes clear, Beijing may have missed the opportunity to either control inflation or prevent a sharp slowdown."
REINING IT IN
China's economy grew 11.5 per cent last year.
This pushed prices up at their fastest rate in 11 years.
The Chinese Government is acting to control growth and inflation, raising interest rates and letting the currency appreciate.
This may be paying off: Last month's trade surplus shrank to US$22.7 billion from US$26.2 billion.
There are fears a Chinese slowdown could coincide with a US recession, putting the world economy at risk.
- Bloomberg
