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  * Market: Defence
    * Published Date: 26/05/2009
    * Report Title: China Defence and Security Report Q2 2009
    * Table of Contents: View Table of Contents
    * Report Type: Market Report
    * Country: China
    * Number of Pages: 68

As anticipated, Q408 GDP data confirmed that China is far from immune to the unfolding global recession, with real growth dropping to 6.8% y-o-y. This marked the weakest outturn in seven years and dragged full-year growth to 9.0%, a sharp decline from the 13.0% recorded in 2007 and the first time since 2002 that the world's third largest economy had failed to register double-digit headline growth. With things expected to get worse before they get better, we are anticipating further grim news from China in H109, and reiterate our below-consensus 5.6% growth forecast for the year.

In view of the increasingly dismal outlook for the Chinese economy, we are expecting further aggressive monetary easing and fiscal stimulus to be rolled out as Beijing tries to avoid a doomsday scenario. Indeed, given that producer price inflation dipped into negative territory on a y-o-y basis in December, contracting by 1.1%, and that consumer price inflation – which slowed to just 1.2% y-o-y in the same month – is likely to follow suit in Q109, the People's Bank of China (PBoC) certainly has scope to slash interest rates.

The sharp economic slowdown currently being witnessed in China has enormous political implications, most notably when it comes to employment – or more specifically unemployment. China's entire political system is built upon the continued prosperity of its population, since as long as people are happy, there is little reason to challenge one-party rule. However, following years of persistent double-digit growth (during which period Chinese citizens largely refrained from greater calls for democracy and overlooked the Communist Party's shortcomings in return for rising standards of living), rapidly weakening economic activity is now threatening to erode the confidence established in the government during the most recent boom period.

Tibet: March marks the 50th anniversary of the Dalai Lama's flight into exile and the passing of one year since the Lhasa riots in which a reported 22 people (although many Tibetan supporters maintain that the number was far greater) were killed and almost 1,000 people detained. It is entirely possible that Tibetan supporters may use any protests to once again raise the profile of their cause. In a similar manner, other marginalised minorities such as Xinjiang's Uyghur population or Falun Gong supporters (who will in fact be marking 10 years since the spiritual movement was banned in July) may also seek to use demonstrations as a platform to further their causes.

Rapprochement with Taiwan continues to dominate China’s foreign policy landscape – with recent announcements of direct flight, shipping and postal services between the two countries – but the mainland has not focused on this to the exclusion of other efforts to stake its claim as a geopolitical power, and is ever-ready to strongly criticise US arms sales to Taiwan.

In Q408 China reiterated its friendship with Pakistan under 2005’s Treaty of Friendship, Co-operation and Good-neighbourly Relations between the two nations, signing 12 memorandum’s of understanding on economic co-operation and free trade, undertook anti-terrorism manoeuvres with Indian forces, and sent a high-level military delegation to Nepal. In the latter case, the meeting was phrased as being part of normal relations between the two countries, although there was talk of how China might help protect ‘Nepal’s sovereignty and geographical unity’. China has also stated that it is willing to boost military ties with Bahrain.

Unrest in the Uighur Muslim-dominated Xinjiang province in north-west China in the middle of the year faded completely from view in Q408, as the economic situation in China became the dominant threat to internal security, with a raft of civil protests, by taxi drivers, laid off workers and other groups across the country over recent months.

China announced a 4trn yuan (US$590bn) stimulus package in November, which it hopes will support the 200,000 new jobs it needs to create each year for university and school leavers, as well as stimulate domestic consumption as its export industry continues to suffer from the economic downturn. A series of infrastructure and public works at its heart could allay some of the distress citizens are feeling from the fiscal climate.

The Chinese arms industry is still booming, but if there is any significant decline in economic growth this situation could change. It has begun competing in the global defence market although as we have said in previous reports arms companies are dogged by over-staffing, inefficiencies and being based far from major manufacturing centres.