Tuesday, January 25, 2011

Strong growth with 'soft landing'

THE Chinese economy grew at an average annual rate of 9.9 per cent in the 1979-2009 period and at 10.7 per cent in the 2001-2009 period. But growth is expected to moderate this year to below 9 per cent due to weaker internal and external environments, and inflation is expected to rise to around 4.5 per cent.


Growth dropped to 6.1 per cent in the first quarter of 2009 due to the global economic crisis but quickly rebounded to 9.2 per cent for the entire year, thanks to the government's huge stimulus efforts and the economy's good fundamentals.


The robust recovery continued through 2010, yielding a growth rate of 10.3 per cent for the year. This has helped precipitate a shift of the global economic gravity towards East Asia.


China displaced Japan as the world's second-largest economy in the second half of last year - though in purchasing power parity terms, China's gross domestic product (GDP) had already been the world's second-largest, after the United States, for many years now.


With renewed confidence, China's economic policymakers reckoned that the country's main economic challenges would stem from external sources. Indeed, China, with external reserves surpassing US$2.5 trillion (S$3.2 trillion), came under mounting international pressure, particularly from the US, to revalue its currency, the yuan. As its exports began to recover and expand, China was also subjected to increasing protectionist measures in developed countries.


Accused by the US of being a currency manipulator, Beijing stood its ground. Last June, however, it let the yuan go off its peg to the US dollar and it appreciated by 2.3 per cent, on top of the 21 per cent revaluation from July 2005 to July 2008.


Beijing has argued that any one-off large revaluation of the yuan would be too disruptive for both China as well as the world, and will not help the US to resolve its chronic trade imbalances.


As Premier Wen Jiabao put it in November, China's strategy of maintaining a 'stable' exchange rate with only gradual and discrete appreciation is vital for China's export-oriented economy. If its export sector were to falter, it would have serious repercussion for many Asian economies. Simply put, if China were to reduce its exports, it would also have to curtail its imports of raw materials from Australia and South-east Asia, and of machinery and high-tech components from Japan, Korea and Taiwan.


But keeping the yuan undervalued for a prolonged period will also hurt China's economy and impede the long-term process of economic rebalancing and industrial upgrading. In the short run, a rigid regime of 'slow and orderly appreciation' may give rise to asset bubbles. Any country with a grossly undervalued currency and with expectations of revaluation will invite a lot of speculative capital inflows, particularly when the global system is awash in liquidity.


In the first half of last year, a lot of foreign 'hot money' did find its way to China's real estate sector and stock market. The housing market was particularly overheated. Last May alone, the average house price in 70 large cities increased by 12.4 per cent. This prompted the government to introduce various measures to cool the market. But these 'have not achieved satisfactory results' as Premier Wen recently admitted. Housing prices rose 7.7 per cent in November.


More seriously, large capital inflows have generated too much liquidity in China. Apart from increasing the risk of asset bubbles, excessive liquidity stokes inflation. Inflation as measured by the consumer price index (CPI) rose from 1.5 per cent in January last year to over 3 per cent in the middle of the year, before hitting 4.4 per cent in October.


The matter came to a head in November when the US Federal Reserve unleashed its second round of 'quantitative easing', flooding the world market with abundant cheap money. In response, the People's Bank of China introduced its own 'quantitative squeezing' by immediately announcing two rounds of a 0.5 per cent increase in the required reserves ratio of bank deposits. But domestic liquidity continued to surge and inflation reached a 28-month high of 5.1 per cent in November year-on-year. Though the inflation rate for the whole period of January-November averaged only 3.2 per cent, it surpassed the government's targeted ceiling of 3 per cent for 2010.


The November CPI hike was caused mainly by a 74 per cent increase in food prices along with a 14 per cent rise for housing, though food prices are expected to stabilise in the December CPI.


Still, the government took alarm at this sudden surge in inflation. Apart from ordering stringent measures such as setting price ceilings for essential food items and outlawing certain speculative activities, the government put inflation at the top of the agenda in its annual Central Economic Work Conference, chaired by President Hu Jintao.


China's inflation is actually quite low by the standard of emerging economies such as Brazil, Russia and India. The inflation rate is currently 6 per cent in Brazil, 7 per cent in Russia and 11 per cent in India. But the Chinese government feels spooked at the first sign of inflation. This is partly because price increases of basic commodities especially, disproportionately affect the poor and lower-income groups. With income inequalities so great, rising inflation is apt to create social instability. Thus, the government has to repeatedly assure the public that inflation will be contained.


By the end of December, the central bank had raised the reserve requirement ratio for banks six times and interest rates twice. The deposit rate is now at 2.75 per cent, as against 5.81 per cent for lending. The rest of the world should wish China success in its efforts to control inflation. As the world's largest exporting country, it can easily export its inflation to other countries.


In mid-October, the Fifth Party Plenum issued the draft Five-Year Plan for 2011 to 2015, setting out the broad policy guideline for China's economic and social development over the next five years. The plan highlights five major development objectives. They include restructuring the economic growth pattern towards greater domestic consumption and less export dependency, boosting market efficiency, and promoting faster urbanisation and regional development.


To be sure, some of the plan's objectives, such as greater efficiency and restructuring economic growth to create better quality of life, are actually old ideas from the previous Five-Year Plan. But they look more urgent this time. The overall institutional environment has also become more favourable for such changes.


More significantly, the latest plan has targeted for priority development seven industries: alternative energy, information technology, biotechnology, advanced equipment manufacturing, advanced materials, alternative-fuel cars, and environmentally friendly technologies. The government is planning to invest up to two trillion yuan (S$390 billion) each year for the next five years to promote these key industries.


Overall, the likely scenario for China's economy this year is a 'soft landing'. The growth momentum may be compromised by the need to combat inflation and rebalance the economy.


The government is confident that inflation will be contained. This explains why the central bank has left the new loan target for this year basically unchanged at 7.5 trillion yuan.


But even if the government regulates food prices, the cost-push elements in inflation - due to real wage increases, including the upward adjustment of minimum wages in the cities - may be harder to tame.


That said, China's growth this year may still end up a little higher than expected, as has often been the case in the past. China's economy is structurally and institutionally biased towards growth. At times, even as the central government wants growth to slow down to reduce overheating, most local governments still push for higher growth in their regions to create more employment and generate more revenue for themselves. China's high-growth dynamics are not likely to disappear soon.


The Chinese economy has been growing at near double-digit rates for the past three decades. China's total GDP today is already a huge base and further high growth would add another 'Japan' in five to six years. China's future growth in the medium term ought to settle down to the lower and more sustainable rates of 7-8 per cent.


Total car sales in China last year reached 18 million units, much higher than in the US. The potential negative implications of this - in terms of pollution, congestion and so on - indicate the risks of such a large economy as China's still growing at such a breakneck pace.


The writer is a professorial fellow and academic adviser at the East Asian Institute, NUS.




China's growth this year may still end up a little higher than expected, as has often been the case in the past. China's economy is structurally and institutionally biased towards growth. At times, even as the central government wants growth to slow down to reduce overheating, most local governments still push for higher growth in their regions to create more employment and generate more revenue for themselves. China's high-growth dynamics are not likely to disappear soon.

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