The main problem China is likely to experience this year is the inflation rate which is set to reach the highest level in 12 years. High inflation is mainly caused by soaring food prices and it is estimated that groceries make up about one-third of the consumer-price index. Furthermore, it is expected that core inflation may pick up due to a recent increase in state-controlled retail fuel prices aimed to help oil processors cut losses and encourage them to increase supplies. Also, reconstruction work after the earthquake in Sichuan province and the heavy flooding in the south will increase demand for construction materials, adding pressure for more price increases.
Slowdown in export and investment growth presents another hurdle for the economy. For example, China's manufacturing expanded in June at the slowest pace in almost three years as growth in export orders weakened for the third month, a survey of purchasing managers showed this week. Indeed, weakening external demand and rising input prices play a significant role in the downturn. Yet, Chinese government is not without blame. New domestic policies, such as strict credit tightening, currency appreciation, Labor Contract Law and removal of favorable policies toward exporters may have significant effect on Chinese economy.