Taking Stock of China's Growth

MAY 19, 2011   THE WALL STREET JOURNAL

By TOM ORLIK

Worried about Chinese growth? Here's another reason: high inventories mean that if demand weakens, output could fall even faster.

The inventory cycle amplifies manufacturing's ups and downs. When demand is strong, firms step up production and add to inventories, giving growth an extra boost. When demand falters, producers go slow and reduce inventories, giving growth an extra kick in the teeth.

During the 2008 crisis, the global collapse in demand saw firms cease production and sell down inventories, exacerbating the economic impact. When growth started to get back on track in 2009, restocking gave it an extra boost.

This process is the same in China. But it is even tougher to find good inventories data than in other countries. What information there is points to high levels of inventory that will damp growth if final demand slows in the months ahead.

Data from the China Federation of Logistics and Purchasing show additions to manufacturers' stock of finished goods in March and April, unusual because the data normally point to falls in inventory. Calculations by Wang Tao, an expert on the Chinese economy at UBS, show that in key parts of the industrial sector, the ratio of inventory to sales has returned close to precrisis levels.

The outlook for demand is tough to call. But there are reasons for concern. Growth in industrial value added was 13.4% year-on-year in April, from 14.8% in March. Real-estate investment remains robust, but a fall in construction because of government controls and oversupply is widely expected.

The joker is inflation. If a moderating consumer-price index means an end to tightening monetary policy, growth should bounce back and worries about the inventory cycle recede. But if inflation remains high, and policy tilted toward tightening, high inventories will amplify any slowdown in the months ahead.

Write to Tom Orlik at tom.orlik@wsj.com