After a Strong Recovery, China’s Economy Unexpectedly Stumbles Again

HONG KONG — Brightly hued men’s underwear in a rainbow of colors is no longer selling well in Europe for the Zhongtian Garments Company in Xiamen, China. Exports are down 30 percent in the last year.

Children’s guitars with bodies resembling cats and cartoon characters are losing their charm for Yuesen Musical Instrument Factory in Huainan, China. And at the Yuzhongniao Outdoor Products Company in Jinjiang, domestic sales and exports alike are declining this year. The Canton Fair, China’s biggest export event, ended on Sunday with few new orders. “We are not even getting many people browsing this time,” said Alice Hong, Yuzhongniao’s sales manager.

After a powerful recovery through the autumn and winter from a V-shaped downturn last summer, China’s economy is unexpectedly faltering once again. Exports are weak. The country’s domestic economy is still growing mostly because of huge increases in lending by state-controlled banks and a surge in off-balance sheet lending. Consumer spending is rising, but not fast enough to offset weakness in other sectors.

That combination has prompted growing concerns among economists and business executives about the sustainability of even 7.5 percent growth in China in the coming years, the government’s current goal after three decades of double-digit growth with only a few interruptions.

The latest sign of trouble came on Wednesday, when China’s General Administration of Customs announced export and import figures for April. On the surface, they looked fairly respectable: exports were up 14.7 percent from a year earlier, and imports were up 16.8 percent.

But April 2012 was an exceptionally bad month for Chinese exports and imports — indeed, dismal trade statistics for that month were the first sign that economic weakness during the preceding winter was turning into a precipitous decline.

This April’s trade figures appeared even weaker when economists looked closer and found that the export growth had been largely propelled by growth in exports to Hong Kong, up 57 percent, and to special customs zones in China for export later, up even faster.

Since Hong Kong’s own data has not been showing large increases in imports from China so far this year, the Chinese government has already opened an investigation into whether exporters are overinvoicing for shipments. Overstating exports can allow companies to evade currency controls and move money into China to profit from the gradual appreciation of the renminbi against the dollar.

Louis Kuijs, an economist in the Hong Kong office of the Royal Bank of Scotland, estimated that with the exclusion of overinvoicing, export growth came to only 5.7 percent.

Over the last few years, economists have tended to pay less attention to China’s exports because they were declining as a share of the country’s total economic output, because of weak overseas demand. But newer research suggests that China may still be dependent on exports.

The reason is that multinationals have been rapidly localizing their purchases of various items like computer chips and auto parts in China instead of importing them from other Asian neighbors. So while total exports may not have been rising quickly in recent years in China, the Chinese content in each dollar of exports has been increasing.

Mr. Kuijs estimated that 20.7 percent of China’s economic output came from exports last year, a figure that had bottomed out in 2009 at 19.7 percent.

In a bad sign for exports in the months ahead, the Canton Fair announced this week that export orders placed at this year’s spring session had fallen 1.4 percent from a year ago. It was the latest sign that steeply rising blue-collar wages in China and a gradually appreciating currency are starting to erode the country’s international competitiveness; foreign investment in China has also begun to level off, while surging in lower-wage countries in the region, like Cambodia and Vietnam.

Li Yong, the general manager at Yuesen Musical, said that many Japanese, Taiwanese and Korean companies in his industry had recently moved to Indonesia as costs climbed in China.

Hilda Wang contributed reporting.

Retail Sales Unexpectedly Fall

Sales fell 0.4 percent in March, missing analysts' expectations for a flat reading, Commerce Department data showed on Friday.

The data suggests consumer spending was considerably weaker in the first quarter than analysts previously believed, and many cut economic growth forecasts for the period.

Prior reports had made consumers look relatively resilient despite an increase in tax rates in January on most Americans.

"The payroll tax increase is hurting," said Ian Shepherdson, an economist at Pantheon Macroeconomic Advisors in White Plains, New York.

Readings for sales have been volatile this year, making it difficult to know how much of the recent weakness has been due to higher taxes and how much might be because of temporary factors related to the weather.

But supporting the view that tighter fiscal policy is the culprit, a closely watched gauge of consumer spending unexpectedly fell in March and the government revised the readings for January and February sharply lower.

These so-called core sales, which strip out cars, gasoline and building materials, fell 0.2 percent last month. This measure corresponds closely with the consumer spending component of the government's measure of gross domestic product.

"The miss in retail sales sends concerns about the impact of higher payroll taxes," said Omer Esiner, a market analyst at Commonwealth Foreign Exchange.

Economists also cited an increase in gasoline prices earlier this year as a factor holding back sales.

Forecasting firm Macroeconomic Advisers lowered its estimate of first-quarter economic growth by three tenths of a percentage point to a 3 percent annual rate.

That would be much stronger than the 0.4 percent rate clocked in the fourth quarter, although much of the acceleration is expected to come from a temporary build up of inventories. Reinforcing that expectation, a separate Commerce Department report showed retail inventories rose 0.4 percent in February when stripping out cars.

Growth is expected to slow sharply in the second quarter largely because fiscal policy tightened further in March, when the federal government began across-the-board spending cuts known in Washington as the "sequester," part of Washington's efforts to shrink the budget deficit.

U.S. stocks declined on the weak retail sales data and as results from major banks failed to impress investors. Prices for U.S. Treasuries rose, while the dollar declined against the yen.

SENTIMENT TUMBLES

A separate report suggested the government's belt tightening was damaging consumer sentiment.

The Thomson Reuters/University of Michigan's preliminary reading on the overall index of consumer sentiment fell to 72.3 in April, the lowest since July 2012 and below economists' forecasts.

Over the entire year, Washington's austerity drive could subtract about 1.5 percentage points from economic growth this year, according to an estimate by the non-partisan Congressional Budget Office.

"The worry is the full reaction to the expiration of the payroll tax cut and to the sequester budget cuts won't be evident until sometime this quarter," said Cary Leahey, a senior advisor at Decision Economics in New York.

Economists said the loss of momentum evident in many economic indicators for March could reflect a warm winter, which may have led companies and consumers to pull forward spending, and a chilly March may have then dulled activity.

Indicators from retail sales and hiring to factory manager confidence were much stronger in February.

SUBDUED INFLATION

A fourth report showed wholesale prices fell sharply in March due to lower gasoline costs. That will come as a relief to consumers beset by high prices at the pump, and could help the U.S. Federal Reserve maintain its very accommodative monetary policy.

Producer prices fell 0.6 percent in March, their biggest drop in 10 months, as gasoline prices tumbled, the Labor Department said. Economists polled by Reuters had expected prices received by the nation's farms, factories and refineries to fall only 0.2 percent.

In the 12 months through March, wholesale prices were up 1.1 percent, the smallest rise since July. Prices had increased 1.7 percent in February.

The benign inflation environment could strengthen the argument for the Fed to keep monetary policy loose as it tries to steer the economy towards faster growth, despite divisions among policymakers over continued asset purchases.

"This is not the time to take away the accommodation," Boston Federal Reserve Bank President Eric Rosengren told CNBC television in an interview.

Minutes of the Fed's March 19-20 meeting released on Wednesday showed the central bank was moving closer to ending its monthly $85 billion purchases of mortgage and Treasury bonds to keep rates low and spur faster job growth.

(Reporting by Jason Lange; Additional reporting by Lucia Mutikani in Washington; and by Nick Olivari, Ellen Freilich and Steven C. Johnson in New York; Editing by Neil Stempleman)