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The world’s fastest growing economy and its engine of growth appears to be headed for a substantial slowdown as per latest data released by the World Bank. China’s exports have started shrinking and even its imports have been marked by a severe contraction. China has been labeled as the world’s factory and nearly 40% of its GDP is exports dependent. A worrisome shrinkage in its exports is likely to pull down its GDP growth rate substantially. With most of the Western world plagued by economic contraction, China’s growth story along with India’s, was a major hope to keep the global economic growth rate ticking. But now, things seem set to change!

The usual outcome of falling exports should lead to a contraction in the foreign exchange earnings and an increase in the trade deficit, which in turn should exert a downward pressure on the local currency and lead to its depreciation. A depreciated local currency would provide impetus to exports by making Chinese goods cheaper. However, Chinese imports have fallen at a faster rate than its exports. This is leading to a situation, where its trade surplus has started growing rapidly. A rising trade surplus exerts an upward pressure on the local currency, something that is likely to hurt Chinese exports and also the global growth rate.

Latest figures released suggest that China’s exports dropped by a 2.2% in November, while imports contracted by an astounding 17.9%. Chinese exports last fell in 2001. The nation’s exports to the US fell by a whopping 6.1% and that to neighboring ASEAN nations by 2.4%. The sharper drop in imports have led China’s trade surplus to jump to a record $40.1 billion. A drop in China’s imports is also indicative of the shrinking demand in the Chinese economy. It appears that the Chinese governmental fiscal stimulus of $586 billion has not had much impact to boost domestic demand as yet.

The Chinese economy, which had been growing at double digit figures since the 80s is now likely to experience a deceleration to 7.5% in 2009. This prediction has been made by the World Bank on the assumption that China’s exports will grow by nearly 4% next year. This may be hard to achieve given the status of the global economic downtrend and slack global consumer demand.

Rapidly shrinking Chinese exports are likely to force its communist government to devalue the Yuan. But with consumer demand collapsing rapidly, devaluation of the Yuan may not bring much respite. The case of South Korean exports dropping by nearly 18% in November on the back of its currency having lost a third of its value against the dollar does not suggest that the Chinese government may have much success by devaluing its currency. It may be noted that despite immense pressure from major Western governments, China has not allowed its currency to float.

The impact of the slowdown is already visible in China, with a large number of factories having closed down in the Pearl River Delta in South China leaving thousands unemployed. Labor unrest and disputes are on the rise leading to social unrest. If things get worse, the social unrest could rise and may become unmanageable for the Chinese government. It could also lead towards the beginning of the end of the Communist dictatorship in China and a move towards democracy, something that the world would be happy to welcome! Hopefully, the government should avoid the repeat of its previous Tiananmen Square massacre this time and be mature enough to let go.