It has been a euphoric August in China. The whole country basked in the reflected glory of the meticulously run Beijing Olympics. With the eyes of the world on them, Chinese athletes delivered a parade of medals and filled their compatriots with pride. Alas, the party is over and attention is turning back to the economy, which is in a decidedly less joyous state. Not long ago, people were fretting that China's economy was overheating. Now it appears that the momentum for growth is faltering. The government's line on economic policy has changed from 'inflation fighting' to 'fighting inflation and guaranteeing growth', with the emphasis on the latter.
Recent economic data, with the exception of exports, all points to a slowdown. Growth in industrial production in July slowed to 14.7 per cent year on year, from 16 per cent in June. The official purchasing managers' index, one of the few reliable leading indicators, fell to 48.4 in July, marking its first fall below the threshold of 50 since 2005.
Meanwhile, the A-share market has been in freefall despite government admonishments to fund managers not to sell, and the drop in crude oil and commodities prices. The retreat of commodities prices and a strengthening US dollar have brought badly needed relief to global financial markets, as they portend a reduced threat of inflation. However, neither A shares nor Hong Kong's Hang Seng Index, which are proxies for investor confidence in the Chinese economy, have benefited.
Why have A shares not perked up? The reason is that China's domestic stock-market performance is not driven by factors linked to global trends. Rather, Chinese investors believe that the domestic economy will slow significantly now, and that any government efforts to stimulate growth will be constrained by the need to contain inflation.
Moreover, many Chinese companies are facing a profit squeeze brought about by the appreciation of the yuan, tougher environmental standards, rising input prices, weaker external demand and the implementation of the new Labour Contract Law. None of these developments can be mitigated by the mere pullback of commodities prices and the US dollar's rebound.
The corporate profit squeeze has not escaped policymakers' attention. In mid-July several senior officials, led by Premier Wen Jiabao , Vice-President Xi Jinping and vice-premiers Li Keqiang and Wang Qishan , visited the key industrial provinces of Jiangsu , Guangdong, Hebei and Shandong , as well as Shanghai, in order to gauge the difficulties faced by smaller companies. The visits were followed by an easing of banks' lending quotas to small and medium-sized enterprises, and a reversal in the yuan-US dollar exchange rate. However, few firms are likely to benefit from the expected increase in bank credit. As share prices have plunged, the cost of capital has risen sharply even for strong companies. Such a funding gap cannot be easily closed by loosening bank lending quotas.