China’s Inflation Obscuring Olympics

Investors who figure that the August Olympic Games will shore up China’s flagging stock market are indulging in wishful thinking, analysts say.

"It is a mistake to try to tie China's stock market performance to the Olympics,” Asian economic expert Donald Straszheim told MarketWatch. "Until the markets in the U.S., Europe improve, and the economic situations in those countries improve, China's equity markets will continue to struggle.”

The approximately $23 billion in Olympic-related investment won’t have a big impact on the macroeconomy and total fixed asset investment, says Matthews China Fund manager Richard Gao.

Looming over other economic considerations is inflation, which threatens to become rampant despite the central bank's best efforts to control it.

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China's consumer prices rose at their fastest pace in nearly a dozen years last month, climbing 8.7 percent from the same month last year and up from the 7.1 percent January rate.

Though only 5.4 percent of the 56 foreign-owned companies operating in China recently surveyed by the Nikkei Business Daily reported already feeling the ill effects of China’s inflation rate, more than 70 percent fear they will feel it soon.

Nearly half of these firms expect China's blistering economic growth to slow after the Olympics end this summer, and almost a third are moving to shift their production outside of China due to concerns about foreign exchange rates, rising wages and employee retention difficulties.

A recent survey of 20,000 households in 50 mainland China cities showed that a record 49.2 percent of Chinese urban consumers think prices are unacceptably high, though fewer now expect the rate of inflation will continue.

Most analysts expect the central bank will continue to try to curb inflation by using tighter macroeconomic and monetary policies; Merrill Lynch recently revised its China interest rate forecast to three hikes this calendar year from two hikes.

However, further rate increases would also increase pressure to let the yuan appreciate faster against other major currencies, adversely affecting China’s exports, which make up nearly 40 percent of its GDP, as exports become less financially attractive to foreign buyers.

China's economy grew by nearly 12 percent last year, its fifth year of double-digit growth, and recent data shows export resilience.

Chinese government figures show January export growth jumped by an annualized rate of 26.7 percent, up from December's 21.7 percent — but the data normally trail coincident economic indicators by a couple of months.

Economists expect weaker consumer demand in both the United States and Europe to reduce Asian export volumes significantly and slow the pace of regional growth.

A Deutsche Bank forecast that says growth in 12 Asian economies will slip to 7.7 percent in 2008, from an average of 9.2 percent in 2007, typifies the view of many private sector economists.

The Shanghai Composite Index, which grew fivefold in two years, is now down to 4000 — that’s 40 percent less than last October’s 6,092.06 peak — and it could drop below the 3000-point level as economic skies continue to darken, according to equity broker Robbert van Batenburg.

"The fear is that with the presence of a large amount of over-capacity, Chinese companies can no longer absorb those over-capacities by exporting excess production to foreign markets,” Batenburg says. "That eats away companies' profits and may be weighing over the whole stock market.”

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