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China's Slowing Economy: What You Need to Know

A Yum! Brands KFC outlet in Beijing on March 6

Photograph by Tomohiro Ohsumi/Bloomberg

A Yum! Brands KFC outlet in Beijing on March 6

Growth in China is cooling—that in itself is no longer news. What’s made headlines recently, though, is that it’s decelerating much faster than anticipated. Here are some important things you need to know about the world’s second-largest economy.

No. 1: The slowdown is for real

Yes, the slowdown is for real; that’s caught many economists by surprise and is fanning worries that China won’t be the hoped-for engine to drive a global recovery. First-quarter GDP growth of 7.7 percent was well below the 8 percent predicted by a Bloomberg survey of economists and even lower than the 7.8 percent rate for all of last year (which in turn, was China’s slowest growth in 13 years). Already, Goldman Sachs (GS), JPMorgan Chase (JPM), and Royal Bank of Scotland (RBS) have pared back their 2013 estimates to 7.8 percent.

Now, with similarly disappointing manufacturing numbers released on April 23 (showing a slowing expansion), China watchers are fretting even more. The so-called flash purchasing managers’ index, compiled by HSBC Holdings (HSBA:LN) and Markit Economics, came in at 50.5, below March’s reading of 51.6 and also below the 51.5 expected by economists. “This paints a picture of a continued painfully slow recovery for China’s manufacturing sector,” said Yao Wei, an economist at Société Générale (GLE:FP) in Hong Kong, reported Bloomberg News. “The government needs to help translate the easy liquidity conditions into real growth.”

No. 2: Beijing actually prefers slower growth, though within reason

It’s also a fact that Beijing actually wants to see slower growth, as part of a not-so-new, yet much delayed aim of achieving quality rather than quantity of growth. China’s economic policymakers know they can’t rely much longer on energy-intensive and high polluting, low-end industries to drive growth. Speaking at a Beijing seminar on April 14, China’s new Premier, Li Keqiang, said, ”More effort should be made to improve the quality and benefits of development, with a focus on promoting economic restructuring and upgrading.”

The continued rise in worker salaries is an added impetus to move to a less labor-intensive and higher-value-added economy. Also, key: shifting from a reliance on exports and investment to an economy more driven by consumption and services.

By necessity, however, that means downshifting from the double-digit annual growth rates achieved over most of the past three decades. ”China is undergoing economic restructuring, which sometimes is not in lockstep with growth,” People’s Bank of China Governor Zhou Xiaochuan told Bloomberg News during a visit to Washington for an International Monetary Fund meeting on April 20. “We need to sacrifice short-term growth for the purposes of reforms and structural adjustments.”

No. 3: The pain will be felt, and by many

Even if Beijing may welcome a less torrid pace of growth, that doesn’t make things any easier for such companies as Boeing (BA), Caterpillar (CAT), andNestlé (NESN:VX), that now rely on China for a significant portion of their business. KFC parent Yum! Brands (YUM), which gets around half of its revenue from China, says it expects this year’s profit to suffer a “mid-single digit” decline, excluding certain items. That’s in part because the fast-food franchise has been hard hit by food safety scares in China, including the spread of bird flu, with sales at its 5,400 restaurants in China dropping by 24 percent in the first quarter. If the Chinese economy keeps slowing, that will only add to the restaurant company’s woes.

Commodity exporting countries that rely heavily on sales to China, such as Angola, South Africa, Kuwait, Chile, and Venezuela, are likely to be big losers too. “Trade data show that Chinese imports of commodities, and industrial metals in particular, have been falling in recent months,” writes David Rees, an emerging markets economist at London’s Capital Economics in an April 24 note. “That is bad news for those emerging markets in Latin America, the Middle East, and Africa that predominately export commodities to China.”

No. 4:  Might there be a silver lining in here somewhere?

There could be some unlikely benefactors of a China slowdown. Those emerging market countries that now directly compete with China to produce cheap shoes, toys, and textiles could finally get some breathing room. “It is not all bad news,” writes Capital Economics’ Rees. “To the extent that China’s structural slowdown reflects its transition from low to middle-income status, opportunities will present themselves for other EMs as China moves up the value chain. We are particularly upbeat on the manufacturing-based economies of South East Asia, along with Mexico, Poland, and Turkey.”

Roberts is Bloomberg Businessweek's Asia News Editor and China bureau chief. Follow him on Twitter @dtiffroberts.

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