- The Washington Times - Friday, December 20, 2002

SHANGHAI, China Of all the nightmare scenarios for Asia's struggling economies mulled over in corporate boardrooms and government offices throughout the region these days, perhaps none is more troubling than the threat of deflation caused by China's cheap exports flooding the global market.
As China and its 1.3 billion people hurtle toward the global economy, the Asian giant's neighbors have become more concerned about the threat of its exporting deflation to the rest of the region and the world.
Their concern is that a flood of low-priced Chinese goods could force manufacturers in other countries to slash their prices to compete, which in turn could trigger deflation throughout the Asia-Pacific region.
"An economic slump in the United States, Europe and Japan and excess production capacity caused by China's entry and growing dominance in global trade, have caused prices of exports by countries throughout Asia to fall sharply," said Pratya Sawetvimon, a Shanghai-based analyst for the Bank of Thailand.
The analyst said the prices of exports by Thailand, Malaysia and several other Asian countries have fallen by at least 12 percent in the first half of this year, a drop he attributed to China's exporting deflation.
"China's low export prices have had such a major impact that all Asian countries are now feeling the pinch of deflation in one form or another to some degree," Mr. Sawetvimon said. "It's a big problem in the region."
Some analysts say China's influence on lower prices in Asia and throughout the world has been caused, in part, by the substantial difference in production costs between China and other countries.
"China is overtaking its Asian neighbors as the manufacturing center of the region, causing a major shift in economic power," said Stephen Wright, a Shanghai-based investment analyst for foreign companies.
"I have heard stories about U.S. companies pulling their operations out of Mexico to set up shop in China because the cost of labor is so low," he said. "This phenomenon is good for China, bad for its neighbors."
Deflation has been creeping into China since early 1998, when most Chinese manufacturers slashed their prices to reduce stockpiles of surplus products that had been piling up in warehouses.
Some economists have raised serious concerns about the global impact of China's falling prices because its currency, the renminbi, is not fully convertible and currently is pegged at 8.277 yuan to the U.S. dollar.
Since the Asian financial crisis in 1997, China's self-styled "proactive" fiscal policy, coupled with a stable monetary policy, have formed the backbone of its economic growth strategy.
China's economy, Asia's largest after Japan's, grew a robust 7.9 percent in the first nine months of 2002, a rate that top Chinese policy-makers hope to continue for the next five years.
Beijing has resisted calls to implement a more flexible exchange rate and ease its monetary policy, with Chinese finance ministers expressing their confidence in the stability of the nation's currency system in statements this month, pledging not to loosen the renminbi's peg to the dollar anytime soon.
Dai Xianglong, governor of the People's Bank of China, the central bank, told a financial conference in Beijing on Dec. 6 that the bank would combat deflation while fostering more economic growth.
"We should guard against inflation, but economic and financial globalization has brought about reduced costs and improved technology," the central bank governor was quoted by state media as saying. "So I believe the priority for us in the next several years is to prevent deflation."
Now that China has joined the World Trade Organization, a move that is opening its markets to increased global competition, policy-makers and economists are beginning to question how long China plans to stick with the fixed-exchange-rate system, as well as the hefty government spending that has supported it.
A report by the International Monetary Fund in April called on the Chinese government to begin a gradual shift to a more flexible exchange rate "as a temporary safeguard against external trade shocks."
Senior Chinese officials, who have tried to assuage the fears of other Asian countries over China's role in the region, have made it clear they won't take actions that could hinder domestic growth.
"China's Asian neighbors can kick the dirt as much as they like, but chances are they won't convince the Chinese to take any course of action that will weaken the nation's economic growth," said one analyst.
Japan, the world's No. 2 economy, watches in shock as China's growth rate continues to outdo its own stagnating economy year after year, challenging its role as the region's financial powerhouse.
In an article published in the London-based Financial Times early this month, Haruhiko Kuroda, Japan's vice minister, and Masahiro Kawai, deputy vice minister of global finance, urged the Chinese government to take measures to curb deflation by loosening currency controls and allowing the renminbi to appreciate.
Some Asian countries are considering anti-dumping measures against Chinese firms in a bid to pressure China to curb domestic deflation, a move that lets them protest without directly challenging Beijing.
A report in China Securities News says China's $10 billion in exports will face several major challenges in the coming year, including an uncertain global economy and less room for the central government to raise tax rebates for exporters, a strategy aimed at boosting Chinese firms.
The report said China's exports are likely to rise 12 percent in 2003, down from an expected growth of more than 20 percent this year, which could help to ease the concerns of its Asian neighbors.
Some analysts say China's export deflation is not necessarily a bad thing, and argue that low production costs will act as a magnet for investment in the region, offsetting a potential threat to regional markets.
"If policy-makers in the Asia-Pacific region respond quickly enough to the weakness in global demand and position themselves in a way that taps China's vast economic potential, then the negative effects of lower prices can be mitigated," said Bruce Minion, a New York-based investment consultant in Hong Kong.
He said China's expansion could boost global trade, helping to reduce deflationary pressure.
"China is also a growing export market for its neighboring countries, which is good for them," he said.

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