UPDATE 2-China's factories slow the tempo in July

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BEIJING, Aug 15 (Reuters) - China’s industrial output slowed more than expected in July after tax changes made exports less attractive, suggesting to some economists that the country’s politically sensitive trade surplus may shrink in coming months.

The output growth of 18 percent, which came a day after a strong rise in retail sales, could point to softness in fixed-asset investment when monthly figures are released on Thursday, some economists said.

“With external demand and private consumption proving resilient, the modest easing in industrial production momentum could be due to some moderation in domestic investment growth in July,” said Qian Wang with JPMorgan Chase in Hong Kong.

Economists said the slower pace of output did not change the broader policy picture. Many expect the central bank, which has raised interest rates three times so far in 2007, to do so again this quarter to rein in inflation, which has jumped to a 10-year high of 5.6 percent because of runaway food prices.

However, policy makers will also be aware of the shadows cast over the world economy by the fallout from the crisis in the U.S. subprime mortgage market. Another worry is the booming China stock market, which keeps defying gravity.

Indeed, economists said unsettled global market conditions could explain why the central bank in recent weeks has halted the yuan’s steady climb, making the currency more or less mark time.


Factories churned out 18.0 percent more goods than in July 2006, down from 19.4 percent growth in June, the National Bureau of Statistics said on Wednesday.

Economists had expected a rise of 19.2 percent.

“The surprising slowdown in industrial output was partly caused by the reduction in export tax rebates,” said Zhao Qingming, an economist with China Construction Bank in Beijing.

China scrapped or cut tax rebates, effective on July 1, on nearly 3,000 export lines, including metals and textiles, to help reduce its record trade surplus and discourage companies from making low-value, energy-intensive goods.

In fact, export growth accelerated in July, but economists said this was due to companies shipping goods that had been ordered before the tax changes were announced.

But with China’s official survey of manufacturers showing declines in overseas orders and industrial output for three months in a row, many economists believe exports will lose steam over the rest of 2007.

“As manufacturers expect export growth to decline, they are now cutting their production a month ahead of time,” said Gene Ma, chief economist with China Economic Business Monitor, an independent research house in Beijing.

Yet another safety scandal concerning Chinese goods -- this time the recall of millions of toys by Mattel Inc MAT.N because of small magnets that could be swallowed and cause injury -- may also hurt demand for made-in-China goods.


Ma, with China Economic Business Monitor, said China would be hit by widening credit market strains if they sap U.S. economic growth and thus reduce demand for Chinese goods. Mingchun Sun at Lehman Brothers in Hong Kong agreed.

“Given the turmoil in global financial markets and uncertainty in the global economic outlook, Chinese exports may be facing tougher times in the future,” he said.

“Because of the comparative advantage of Chinese exports, the export growth won’t slow down too much, but it should go back to around 20 percent instead of 30 percent,” Sun said.

Rainstorms across much of China that triggered floods, landslides and other disasters probably contributed to the dip in output in July, economists said.

Ma said Beijing’s campaign for a greener economy might also be having an effect, noting slower growth in output of power, cement, steel and iron.

Still, economists said the slower tempo was not dramatic and had to be seen in context: in the first seven months of the year, factory output was still up 18.5 percent from the same period last year. By contrast, India’s factories in June produced 9.8 percent more goods than a year earlier.

For the first time, China, the fastest-growing of the major economies, has contributed more than the United States to global growth so far this year, according to the International Monetary Fund.