Very clearly there has been a sharp slowdown, but you must be careful with China’s reported growth statistics.  Unlike most of the rest of the world, China just reports year-over-year growth statistics, and not quarter-over-quarter data. This makes it hard to track trends and compare with other countries. It also means that, as best as we can tell, on a quarter-over-quarter basis China’s GDP in Q4 of last year was probably flat or slightly positive or negative, which sounds a lot worse than the reported 6.8%.  On a quarter-over-quarter basis, Q1 of 2009 may be negative.  On a year-over-year basis, growth will be more in the 5% range for the whole of 2009.

In general, we build our forecast based on sources of growth.  China now faces contracting exports, slowing investment, and weakening consumption. In China, a critical source of growth is the property markets – both residential and commercial – which are continuing to contract this year.  This contraction weighs on investment.  Investment in China is 40% is of GDP.  Property is 20% of this 40%, or 10% of total GDP.  That contraction creates a pretty big hole to fill up.  At the same time, exports are contracting and will continue to contract.  Imports are contracting at a faster rate, and this may keep going for a few months.  Things can deteriorate ahead, reflecting a deterioration of external and internal demand. 

Government investment is the other area adding to growth today.  But, despite government investment and the rollout of China’s stimulus package, growth will be slower than the optimistic projections.  Government spending will not be able to boost consumption as much as hoped.

Consumption growth is slowing.  Retail sales have been propped up by government discounts to rural families to help them purchase items such as appliances.  China’s urban population is responsible for 75% of consumption, and rural families can’t make up the difference.  Job losses are continuing and may be higher than previous government estimates.  There is still downside risk to consumption.

China is in a volatile environment, fueled by a fear of job loss.  Traditionally, it is a country of savers, and it faces the risk of increased savings at the expense of consumption.  There are not many signs of shifting to consumption-fuelled growth, especially since the fiscal stimulus (which will support growth) is focused on infrastructure.

We believe our forecasts are reasonable, but we also look at the other scenarios.  One factor that could accelerate growth – and this is a big factor – is the trajectory of the US and global economies.  Consensus still expects the G3 economies to bottom out by early in the second half of this year and stage a recovery by late this year, and, if so, they could boost demand for Chinese goods.  Our view is that recovery will not occur before at least the first half of 2010, and there is risk that the expansion will be sluggish and well below potential growth.  Most of China’s exports are bound for the US, Japan, and the European Union. 

The global and US outlook really determines the outlook for China.  Optimism for China requires a strong global recovery.

Given that most of China’s investment is financed by retrained profits (which there won’t be much of this year), capital expenditure is likely to be weaker.  Furthermore, further investment could further exacerbate existing overcapacities.

The second key assumption underlying an optimistic scenario is that monetary and fiscal policy responses will be effective to support and boost growth – especially consumption-led growth.  But, despite the fact that China has been successful implementing infrastructure projects (its stimulus package contains a greater share of infrastructure spending than does the US package), we do not believe these projects will employ that many people. There is an increasing risk that Chinese policy response may lead to a temporary boost in growth midway through the first half of this year, only to slow again as the external environment remains weak.