Inflation could slow the China juggernaut

The Australian resources sector has been riding high on the back of China for the past decade, led by record commodity prices and an insatiable demand from the Chinese.

The strength of China also helped temper the effects of the global financial crisis, especially in WA, which has strong employment numbers (unemployment in WA is 4.4 per cent compared with the national figure of 5.3 per cent).

As the European debt crisis worsens, the stock market continues to look to China for any indication it is slowing.

Last week, a raft of economic data came out of China, so let's take a look at what the numbers are telling us.

In August, the Chinese trade surplus fell to $17.8 billion for the month, down from a surplus of $31.5 billion in July.

Imports were at a record monthly high in August which contributed to the reduced trade surplus, showing that domestic demand was becoming increasingly important to the overall Chinese economy.

With Europe and the US slowing at a rapid pace you would expect China's trade surplus to continue to fall in the coming months as its export markets tighten.

Data released on Friday showed that retail sales jumped 17 per cent in August, while fixed asset investment, a measure of government spending on infrastructure, rose 25 per cent in the first eight months of 2011.

China's Gross Domestic Product (GDP) expanded 2.2 per cent in the second quarter of 2011, giving an annual GDP growth rate of 9.7 per cent for the year.

This is confirmation that China is still growing strongly, however, such a high growth rate doesn't come without its own set of issues, namely inflation.

The inflation rate in China was 6.2 per cent in August, down from 6.5 per cent in July, and still well above the government's target of 4 per cent.

China's central bank has been busy trying to temper the inflation rate by raising interest rates five times since October 2010 and also increasing the reserve ratio requirements for banks in the country nine times during the period.

Increasing the reserve ratio requirements for banks is effectively the same as raising interest rates as it means banks have to hold more cash in reserve, which reduces the pool of funds available for lending.

Chinese banks are also on notice from ratings agencies Moody's and Fitch after the downgrade of the US credit rating in early August.

In July Moody's expressed concern over potential bad debts held by local governments in China, which could be up to 25 per cent of China's annual economic output.

Rival ratings agency, Fitch, has echoed these sentiments and both Fitch and Moody's have complained that a lack of transparency at Chinese banks may affect its future credit worthiness.

Tying all this data together shows us that China is still growing strongly, led by domestic demand, although it does have a tough task ahead to keep inflation under control and manage its rapidly expanding economy.

For now, it appears that China will continue to roll on which is positive news for the resource stocks on the Australian stock market, although attention will need to be paid to any wobbles in commodity prices going forward as this could be the signal to the world that all is not well in China.

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_Information contained in this article does not consider your personal circumstances. You should consult a stockbroking professional before making any investment decisions. Sentinel may hold positions in stocks discussed from time to time. _