China's Economy Slows Moderately, Raising Hopes of a Soft Landing

China’s economy expanded 9.5% in the second quarter of 2011, which is faster than the consensus forecast of 9.3%. The annualized figure represents a continuing moderation from the 9.7% expansion in the first quarter and 9.8% growth in the last quarter of 2010, raising hopes that the country can avoid shocking the economy with an abrupt fall-off in growth.  

“This set of data should dispel concerns over a hard landing in China,” says Wendy Liu, Head of China Research at European bank RBS. Both industrial production and retail sales performed better than expected, she noted.
Fixed asset investment also held up, although year-to-date growth in urban FAI slowed 25.6% in June from 25.8% in May (see table below). Month-to-month, urban FAI deteriorated minus-1.4% in June compared with May, which can further hold back GDP if export growth continues to slow (17.9% in June versus 19.4% in May) and retail sales stall.   
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Inflation, which can hamper retail sales among other things, remains a concern. The consumer price index surged 6.4% in June, from 5.5% in May and just 3.3% in all of 2010. The central bank has been trying to tame inflation expectations by raising interest rates and the banks’ reserve requirement ratio (RRR).
“There is the possibility for a 25bps interest rate hike in August, but the chance for another RRR hike, while there, is low,” says Liu.
The central bank’s next moves and other government policy changes will be watched closely because any misstep may derail an orderly moderation of GDP growth. A hard landing in China can cause political and social unrest, and threaten Communist Party rule.

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