Inflation Slows, But So Does Growth

The Chinese CPI (consumer price index) rose just 4.9% in August. Although the PPI (producer price index) is more important for OPSA and our customers, the CPI slowdown is significant. It is down from 6.3% in July and 7.7% back in May.

However, as price increases slow, so has growth. Second quarter GDP growth was only 10.1%, down from 10.5% in Q1. I've often read that China needs about 10% growth to maintain a stable employment level. Some economists are now predicting growth will fall to single digits in Q3.

Several economists in China are now calling for economic stimulus to businesses to jump-start growth. The stabilization of the RMB to the USD may be part of this stimulus.

It sure didn't take long to go from talking about an overheated economy, to a slowing one in need of stimulus. I will be watching to see what all the macro developments mean for our business and our customers.

Madison International Trade Association Event

Back in May I was asked to be a speaker at a Madison International Trade Association (MITA) event on rising prices for goods from China. The event was last week and I will be sharing information from it here in our OPSA blog.

I am a MITA member, even though I'm 2.5 hours away in Green Bay, and it is an outstanding group. I met some very interesting people that day and hope to follow-up with several of them.

The first section of my presentation was on whether producer prices in China are rising faster than producer prices in the US, and obviously they are as the chart below indicates.

The chart compares the Producer Price Index in the US (excluding energy and food) to the manufactured goods PPI in China.

Next I summarized the reasons for this situation. I've discussed most or all of the factors in previous posts, but I'll use slides from the presentation to give additional details on them in future posts throughout July. I will also continue on the Top Ten Pitfalls to Avoid in Chinese Outsourcing series.

Perfect Storm of Cost Issues

Alexandra Harney has written an excellent article posted at Slate.com on the cost issues in China. The article titled "The Last Days of Cheap Chinese - Why American consumers are about to start paying more for clothes, electronics, toys, and just about everything else".

http://www.slate.com/id/2188409/

In the article Ms. Harney describes the "perfect storm" of cost issues for Chinese manufacturers. These are the same issues I've mentioned in previous posts - appreciation of the RMB, labor law changes, labor supply shortages, raw material costs, and oil prices. Actually she leaves out the actions the Chinese government has taken (like eliminating some VAT rebates) to slow economic growth and avoid further domestic inflation.

Ms. Harney ends the article by describing prospects in other low-cost countries like Mexico and Vietnam. She concludes that China is still the best option for most sourcing efforts.

I agree completely with the observations in the article and the conclusions - China is still the best option, but the era of very low prices is over for now.

Inflation in China

The following article does a good job of demonstrating inflation issues in China and highlighting its risks for the global economy. Several of our customers have experienced significant price increases this year, so we're living this situation.

http://www.marketwatch.com/news/story/chinas-inflation-its-spillover-whole/story.aspx?guid={804FFB25-BA02-4737-B3C7-0E57DB5F4AEE}&siteid=yahoomy

Although inflation in China is a big issue, there are several things working to offset it. First, the Chinese government is working to improve infrastructure and offer tax incentives for factories to locate in rural Western and Northern areas of the country. These areas have lower costs as they have not benefited yet from the strong growth of the economy.

Second, productivity gains are really beginning to take hold in Chinese factories. There is huge potential for productivity growth in China as it has previously not been a focus at all.

For OPS America, we know we need to help our current partner factories improve their productivity and work harder to find new partners in the north and west. Both of these are challenges for us in 2008 and, likely, beyond.