China's Economy May Overheat in 2010

China's economy "weathered" the global downturn better than most economies. In fact, the country’s Gross Domestic Product expanded by an average 8.45% in 2009, the fastest in the world. Yet, the astonishing recovery was supported by a vast fiscal stimulus and loose monetary policy. And looking ahead, China’s economy may overheat and bring inflation to elevated levels thus hampering future growth.

Indeed, China’s growth in 2009 was largely a result of 4 trillion yuan stimulus package directed mostly to infrastructure projects and lending. For example, in December only, China's wide M2 measure of money supply and fixed asset investments grew almost 30% year on year. On the other hand, although putting a lot of cash into an economy during a slowdown may stop job losses, boost confidence and stimulate growth, can also create excess capacity and boost imperfection across the financial system.

In addition, China has been keeping the value of its currency yuan pegged to the US dollar at very low levels.  And with greenback having depreciated significantly in 2009, the trade-weighted value of Yuan also declined, making foreign goods more costly in China. Adding to that already high food prices, a result of severe weather conditions in northern regions, and inflation may get out of control. So, under these circumstances there is a big pressure on wage growth and companies are likely to raise prices to cover costs which will depress spending among Chinese consumers.

Anna Fedec,
1/26/2010 5:15:20 PM