Though China's economy is surging ahead with almost all economic indicators favouring the current economic situation, it is not likely to continue with the same momentum that it had been expected. True, China's economy continued to forge ahead in May on the back of strong domestic and external demand, with both investment and consumption climbing at double digit rates. Inflation also moved higher. While the recent spate of wage hikes on China would exert upward pressure on prices in the longer term if there is no corresponding increase in productivity. The consumer price inflation is expected to decelerate in the coming months as food and world commodity prices show signs of easing.

It is true that there has been a persistent surge of the China's exports in May amid growing uncertainty in the European economy also raised hopes that the potential impact of the European debt crisis on global trade might be less severe than expected. However, with most of the European countries planning for spending cuts and tax hikes in the months ahead to restore fiscal discipline, mainland China's exports are bound to advance more slowly going forward.

As was discussed in the last issue of The Stitch Times, The People's Bank of China had announced on 19 June that it would increase the flexibility of the RMB and re-peg it to a basket of currencies, thus effectively ending the US dollar-RMB peg. It also stated explicitly on 20 June that there would be no one-off revaluation of the RMB against the US dollar. Mainland China has been holding the RMB steady at about 6.83 to the, US dollar since mid-2008 in an attempt to cushion its economy from the global financial crisis.

It is expected that under the new arrangement, there is likely to be more day-to-day volatility in the US dollar-RMB exchange rate. It also implies that the RMB could appreciate or depreciate against the US dollar. Despite the change, however, The Stitch Times had forecast that the RMB would gradually appreciate, reaching around 6.65 versus the US dollar by the end of this year, or an appreciation of about 2% from its current level.

The internal economy of China is strong and its economy continued to forge ahead in May. Domestically, fixed asset investment in urban areas climbed 25.41% in May after rising by the same rate in April, while the retail sales of consumer goods gained 18.7%, slightly faster than the 18.5% growth of the previous month. Inflation also rose with consumer prices jumping 3.1 % in May after increasing 2.8% in April. In the first five months, consumer prices rose 2.5%, of which over 90% was due to increases in food and housing-related prices.

Export Growth Likely to Decline

There is no immediate threat to growth pace of Chinese exports. The persistent strength of external demand amid growing uncertainty in the European economy was all the more impressive. In May, mainland China's exports grew at a faster pace of 48.5% after rising 30.5% in April and 28.7% in the first quarter. In the first five months, China's exports grew 33.2% compared with a contraction of 16.0% for the whole of 2009. During the period, exports to the European Union (EU) climbed 34.4% compared with the 24.8% growth recorded for exports to US.

While, strong exports by China raised hopes that the potential impact of the European debt crisis on the global economy might be less severe than expected. But this not take in to account the fact that the debt crisis in Europe only began to deepen in the second quarter implying that its impact on the global trade will not be felt until later this year. With Europe being the Chinas biggest market absorbing over one-fifth of its total exports, any noticeable slowdown in Europe's imports could have a substantial impact on the Mainland's export sector.