China's economy cools

Liu Xia Feng does not pretend to understand subprime mortgages or international finance. And a man who sells wooden walking sticks and rolling pins may not seem to be a good global economic barometer.

But Mr. Liu operates one of the tens of thousands of shops in Yiwu's International Trade City – a cornucopia of Chinese-made products that fills five massive malls. He says some of his overseas customers are now late in making payments. "We don't understand these big theories, but we are certainly feeling the impact," he says.

His concern is repeated again and again by Chinese exporters big and small. As export growth falls, the pace of the world's fourth-largest economy is slowing. Official figures released Monday showed China's growth throttling back to 9 percent over the past three months, down by a quarter from last year's annual rate.

Hopes that China's healthy domestic economy might protect it from the effects of the global slowdown are now fading. The export growth reduction coincides with a Chinese real estate slide. "There is a little bit of a cushion, but not enough to save anyone else's bacon," says Arthur Kroeber, who heads Dragonomics, an economic analysis firm in Beijing. "The big economies are going to have to get out of this on their own."

Exports have been a major driver of Chinese economic growth over the past three years, with foreign sales accounting for about one third of the rise in gross domestic product.

The prospects of a recession in the US and Europe, which together buy more than half of China's exports, is thus "of great concern," said Du Ying, vice minister of the National Reform and Development Commission, which oversees China's economy, last week.

"Real export growth will clearly slow to zero in the next few months and maybe even contract," predicts Paul Cavey, an analyst at Australia's Macquarie Bank in Beijing. Most of the apparent growth reported Monday was attributable to currency fluctuations and inflation.

"The real danger," Mr. Cavey adds, "is that there will be a simultaneous downturn in both the external and domestic sectors" for the first time in more than a decade "because domestic demand is slowing."

A massive infrastructure boom over the past decade that has seen China expand its roads, railroads, energy-generating capacity, and ports at a rate unmatched in history is beginning to tail off. That weakens another pillar of economic growth.

The government is pledging to take steps to face the danger. "Financial, credit and foreign trade measures will be carried out in the near future in response to the slowing trend of the country's economic growth," the official news agency, Xinhua, reported Sunday night after a meeting of the State Council, China's cabinet.

Xinhua said "special attention" would be paid to infrastructure and encouraging banks to lend more. But with so much already built, it will be hard for the government to maintain such a fast rate of growth in capital investment.

Especially troublesome is a recent real estate slump, which has a knock-on effect on key sectors of the economy such as the steel and cement industries.

Property and affiliated sectors account for almost half of China's fixed investment growth, which in turn contributed five points to the economy's 11.9 percent growth rate last year, points out Xiang Songzuo, an independent economist. "The real estate slump will have a very significant impact on growth," he says.

One bright spot is that Chinese banks have been barely affected by the financial crisis that has brought some of America's and Europe's biggest financial institutions to the brink of disaster.

The Chinese financial system is smaller, less international, and less sophisticated than its Western counterparts. The largest Chinese banks are state owned, which also means that with the government effectively guaranteeing their loans they do not suffer from lack of trust among themselves.

At the same time, because the financial system is relatively undeveloped, Chinese companies do not rely on money markets or on the commercial paper market for their daily operational capital. They keep cash reserves instead, which means there is less danger of a credit crunch stifling the real Chinese economy.

This offers the hope that consumer demand – an increasingly important element of China's economic growth – will hold up enough to prevent a hard landing for the country's economy.

That is the direction in which Yu Ping Wei's thoughts are turning as she wonders what to do about the fact that fewer and fewer foreign buyers have been showing interest in her jewelry stall here over the past three months.

Dependent mostly on the US and European markets for the coral necklaces and shell bracelets that she sells from her booth in Yiwu's International Trade City, she has seen her business drop off by 30 percent since July, she says.

"We will have to come up with new designs and try to sell to tourist cities in China," she suggests. "The Chinese market is potentially very big if we can get into it."

That is a difficult leap to make, though, for companies such as Mei E toys, which sells almost all of its plush toys abroad. Sales have dropped 10 percent since the summer, says owner Jin Mei E, "but we can't cut prices because raw materials and labor costs are going up." She adds, "My profits are down."

Ms. Jin's response to the crisis has been to fire a quarter of her workforce, in a bid to stave off the fate of the 5,000 small manufacturers in Yiwu that have already gone bankrupt this year, according to China Business Daily.

The largest such victim, Smart Union, a firm in Guangdong Province that made toys for Disney Corp., went bust last week, leaving 6,500 people out of work.

The government has promised to reduce the Value Added Tax that exporters pay, and in another bid to prop up foreign sales over the past three months it has virtually stopped increasing the value of the Chinese currency, the RMB, whose appreciation was making Chinese goods more expensive internationally.

Such moves, however, "risk going back to the old export-driven low-cost model [of economic development] the government has been trying to escape," warns Cavey. "Structural regression would be very bad for China."