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Just the Start of a Flood of Chinese Goods?

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BEIJING - From metals to machinery, China is increasingly relying on exports to find an outlet for excess production pouring out of factories built during a two-year investment frenzy that authorities are now labouring to tame.

The consequences of the oversupply will be far-reaching. Within China, inflation is likely to remain at bay as firms cut prices rather than output in order to preserve market share. That would weaken the case for higher interest rates.

Beyond China's borders, a fast-growing trade surplus will provide ammunition for critics calling for a stronger yuan and could provoke more trade disputes like the row with the United States and the European Union over surging textile exports.

"We remain concerned that there remains a general underestimation of the scale of the supply shock which is unfolding in China," economists at Barclays Capital wrote in a report. "It is difficult to see anything other than a deepening of trade tensions with China over the coming months."

China dodged EU quotas on its textiles by agreeing late on Friday to voluntary curbs on export growth. But a deal with Washington, which has taken a harder line and has already imposed quotas on seven textile categories, has yet to be negotiated.

And then there are shoes: Brussels is unhappy that imports of some Chinese shoes have jumped nearly 700 percent since January. And bikes: the EU Commission is proposing raising tariffs on Chinese bicycles next month to 48.5 percent from 30.6 percent.

These are labour-intensive, low-technology sectors. What strikes businessmen and economists is how quickly Chinese producers are also displacing imports of more sophisticated goods and, at the same time, exporting more of them.


Clothing and textiles were the biggest contributor to a swing in China's trade balance to a surplus of $21 billion in the first four months of 2005 from a deficit of $11 billion a year earlier.

But Rob Subbaraman of Lehman Brothers in Tokyo said China's efforts to export its oversupply problem, coupled with its march up the value-added ladder, had also led to a swing in the category of machinery and transport equipment to a $14.8 billion surplus over the same period from a $1.1 billion deficit.

"That highlights a new fact: China has become a net exporter of capital-intensive goods," he said.

This was bad news for countries such as South Korea that have had a traditional comparative advantage in building machinery.

"To do all this investment in steel, property, aluminium, roads, China's got the choice of importing machinery or building it themselves. And they have been setting up the capacity to build more equipment themselves," Subbaraman said.

With government curbs now biting, investment demand is slowing and China can't find a market at home for all it makes.

That explains why, in a short space of time, the country has become a net exporter of steel and aluminium and is even starting to export cars.

To Joerg Wuttke, vice-president of the EU's Chamber of Commerce in China, fast-rising exports are a distress signal that demand at home has dried up.

"If domestic consumption isn't there, companies look outside China because they don't have sufficient margins here. China is one of the most competitive markets in the world by any measure," he said.


Wuttke recalled how Chinese producers, lured by plump margins, rushed into the global market for vitamin C in the late 1990s, when it was dominated by a few Western and Japanese firms.

Within a couple of years they had doubled global manufacturing capacity of 60,000 tonnes. Prices of vitamin C duly tumbled. In the ensuing shakeout, only a handful of the 100 new Chinese firms survived, albeit with a 40 percent market share.

"In many industries, we will see similar patterns," Wuttke said. "At this stage, China is a supply-side story. It has to turn into a demand-side story and start consuming more."
China's monthly trade surplus almost doubled in May to $8.99 billion, buttressing the case of U.S. officials and many private economists that the yuan's decade-old peg near 8.3 per dollar undervalues the currency and gives exporters an unfair edge.

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