As the risk of deflation looms large on top of weaker exports and declining private real estate investment, China's economy may continue to slow down in the quarters immediately ahead but regain growth momentum in the second half of next year, according to a Morgan Stanley report released on Wednesday.

In its China Economics Outlook for 2009, the Hong Kong-based Morgan Stanley Asia forecast China's baseline GDP growth would be around 7.5 percent next year, with the bull and bear scenarios projected at 9 percent and 5 percent respectively.

The projection came after the country's economic indicators showed that the impacts from the global financial crisis on China's tangible economy have become much severer.

The exports totaled US$115 billion last month, down 2.2 percent year-on-year in the first monthly decline since June 2001, the General Administration of Customs said on Wednesday. The previous decline, a much smaller 0.6 percent, reflected slumping US demand after the tech bubble burst.

The producer price index (PPI), a measure of inflation at the factory level, decelerated sharply to an annual rise of 2 percent in November. It was also slowest rise for the PPI since May 2006, which prompted worries about the fast-slowing economy and rising deflation risks.

Late last month, the World Bank has revised down its forecast for China's GDP rise of next year from 9.2 percent to 7.5 percent.

Morgan Stanley Asia chief economist on the Chinese economy Wang Qing said that three factors, namely the cooling-down in real estate investment, a massive de-stocking of raw material inputs in the immediate aftermath of the collapse of international commodity prices and the weakening external demand, had caused China's economy to slowdown rather sharply.

The "triple-whammy impact" however could barely maintain its full force throughout 2009, although the ravage would likely continue to be felt though in the first quarter of next year, he said. "We believe that China's economic outlook for next year is best characterized as getting worse before getting better, laying the foundation for a firmer recovery in 2010."

As the fiscal stimulus package came much faster this time than that during the Asia financial crisis, Morgan Stanley expected the effect to be apparent by mid-2009. Besides, the slow recovery of the G3 economies -- the United States, European Union and Japan-- after the unprecedented monetary and fiscal policy actions might have led to an improving external demand by the second half of next year and thus would contribute to a modest recovery of the Chinese economy.

REAL EATATE CONCERN

Identifying real estate as the biggest swing factor among all scenarios, Wang said that weakening external demand was not the primary reason for China's sharp economic slowdown as deceleration in exports had been gradual and taking place since mid-2007.

It was the macroeconomic tightening policy package launched in late 2007 to avert overheating that has hit the property sector hard. As a consequence, real estate investment has slowed substantially, diminishing demand for key construction materials, such as steel, cement, and aluminum, and housing-related consumer durable goods, he noted.

Wang envisaged a significant decline of six percent (in real terms) in real estate investment from the private sector next year, contending that the chance of a massive industrial collapse on a nationwide scale was small.

To activate the property market, Chinese government has rolled back austere measures previously taken to prevent the economy from overheating, reduced taxes and cut interests.

"There has been a welcome correction in property prices, we expect housing affordability to increase, sentiment to improve, and property sales to stabilize by mid-year 2009", said the report. "Further property-sector-boosting policy measures will likely be implemented in the coming months."

DEFLATION RISK

In this report, Morgan Stanley Asia also revised its Consumer Price Index forecast for 2009 from 1.5 percent down to -0.8 percent, pointing to a "high deflation risk".

From the supply side, the bursting of the international commodity price bubble since October has spawned a sharp decline in the prices of raw materials imported by China. Moreover, weakening exports that are expected to continue amid a synchronized recession in G3 economies also exacerbated the problem of production overcapacity, limiting Chinese producers' pricing power, it said.

"Deflation is not always a bad thing. The challenge is to prevent deflationary expectations from getting entrenched. This necessitates a strong, preemptive monetary policy response," Wang said.

Morgan Stanley therefore expected China's central bank to cut benchmark interest rates aggressively by an additional 162 basis points over the course of 2009. And to ease deflationary expectations, the cuts will most probably be done in the first half.

Although China's economy would steer clear of the extreme downside risk of an outright hard landing after current public-sector-driven growth helped achieve the headline GDP growth and job creation targets, the stimulus would not deliver nearly as strong corporate earnings growth as when the same level of headline GDP growth was fueled by buoyant private-sector spending.

"China's macro-economic environment will be relatively job-rich but profit-deficient in which bonds tend to be favored over equities," Wang said.

(Xinhua News Agency December 11, 2008)