STRONG output in China's production sector, despite capacity restraints, may prove to be Zhu Rhongji's strongest ally in bringing the economy under control without severely curtailing growth. Latest figures for economic growth for the six months to June 30 show gross domestic product up 13.9 per cent, compared with 14.1 per cent in the first quarter and 12.8 per cent for all of 1992. The growth rate is also up from 10.6 per cent in the first half of last year. The new figures suggest that the rate of increase in growth is beginning to level off at admittedly high rates - nominal growth being about 27 per cent - in the first two quarters of the latest year. The same trend is evident in the figures for gross industrial output, up 21.5 per cent on average in the first half of the year, compared to 18.2 per cent for the same period last year. Other evidence of capacity restraints - that is, the limits to production affecting the economy's ability to grow faster - are, of course, reflected in the high inflation rate and the increased demand for imports. When an economy is pushing up against its inherent production capacity restraints, the first to be affected is inflation where too much money is seen to be chasing too few goods in the domestic economy. Prices begin to rise in an attempt to ration out goods through the price-fixing system. This has been happening on the mainland where inflation is at 12.5 per cent, up from just five per cent in the first half of 1992. One way to extend the capacity to supply goods effectively, however, is to increase imports to satisfy domestic demand. This, too, has been occurring in the last two quarters with total imports increasing 23.2 per cent to US$40.69 billion. At the same time, exports rose only 4.4 per cent to $37.15 billion. This has resulted in an overall trade deficit for the half year of $3.54 billion - the first in three years. The failure of exports to grow any faster may also reflect the diversion of goods for the export market to the domestic arena to satisfy demand. All this is important to Mr Zhu as he embarks on his quest to cool the economy because it means he can concentrate his efforts very strongly on the financial and property sectors. These are clearly the two sectors of the economy that are way out of control, especially with money supply growing by a massive 50 per cent in the first half of the year. The money and the new opportunities for development in the Chinese economy have clearly created a speculative bubble, which needs to be controlled, lest it bursts. Its importance in the whole China economic equation could also help explain why Mr Zhu had to take over the running of the People's Bank to make his command over the economy complete. With the production sector bumping up against the capacity restraints - without further and necessarily longer-term investment - Mr Zhu does not have to worry about sudden problems emerging. Since capacity restraints have been reached, there is no likelihood of this happening. Mr Zhu also does not have to worry about a sudden slump in production because some slight decline cannot be a bad thing, if industries are running at, or in excess of, their working capacity. What he needs to do is to bring under control the source of demand in the economy - and the source of speculative investment - the rapid growth in the financial sector (and the money supply), while protecting the returns of the agricultural sector. He has already instituted steps in this direction in the form of higher interest rates, the vetting of loans, drawing the savings to the banks, assuring farmers they will be paid, and putting teams on the ground to monitor developments in financing at a provincial level. But while he is moving to bring domestic pressures under control, his biggest problem may be coming to grips with foreign investment, and its role in the present economic overheating. To ensure greater control, he may feel that his aims could be better achieved if there was at least a slowdown in the foreign investment entering China. But he will have to exercise real care in dealing with the external sector for two reasons. First, he will not want to use a heavy hand so as to frighten foreign investors away. In the longer term, they will be vital to the country's future development of its production capacity. Second, it is the increase in output of the foreign-funded enterprises that is fuelling the growth in the production of goods to meet both internal demand and the export trade. The figures for the first half of the year reveal that output of foreign funded enterprises rose a massive 68.7 per cent over the opening six months of last year. Collective enterprises had a much slower, but still impressive growth of 45 per cent, while the state sector had an expansion in output of a mere 10 per cent over a year earlier. All of this means that Mr Zhu has a delicate balancing act to perform over the next few months if he is to pull off an economic cooling, while avoiding a crash. But, at least, he has the advantage of being able to concentrate on the financial sector, and its excesses, without worrying too much about the production sector. It is doing quite nicely and can easily live with a slowdown in other sectors of the economy. HONGKONG'S provisional trade figures for June, due out this week, are expected to come under closer scrutiny than usual after the apparent easing in export growth in May. Analysts will be examining the June figures to determine if the May slowdown was an aberration, or an indication of a more serious setback to export growth. The May figures showed an unexpected slowdown in re-export growth to a 17.1 per cent annual rate and domestic exports actually declined 6.5 per cent on last year's figures. The figures are important in themselves because any sustained slowdown is likely to have a substantial effect on the future growth of the whole economy. They are also important when set against imports, which, in May, grew by 11.3 per cent, or slightly more than the 11.1 per cent increase in total exports. This means that the adverse trade balance for Hongkong in May was $5.64 billion, compared with $4.94 billion a year earlier. For the year to date, the trade deficit is $24.01 billion, up from $22.08 billion in the same period last year. These figures are all the more significant when looked at in the context of what is occurring in the economies of the territory's main export markets. China , now the biggest domestic export market, as well as Hongkong's prime re-export trade partner,has just embarked on a comprehensive programme to slow its own economic growth. That move alone is likely to reduce demand throughout the Chinese economy - even without a strict austerity programme - and this will have a direct impact on Hongkong exports. While the slowdown in the domestic export and re-export figures in May came as a surprise, a slowdown in June would be likely to be viewed more seriously. Two months in the trade calendar do not make for a trend by any means, but a slowdown in consecutive months would be a cause for legitimate concern - especially with China attempting to bring domestic demand under control. Ian Perkin is chief economist with the Hongkong General Chamber of Commerce. The views in this column are his own and may not necessarily reflect chamber policy.