China's key economic challenge is to rebalance the economy, said
the World Bank in its latest China Quarterly Update
released in Beijing today. "The concerns about high investment
growth and the pattern of growth have to be addressed by structural
reforms," says Louis Kuijs, senior economist on China and main
author of the Quarterly.
With supply growing broadly in line with demand the main
short-term macro imbalance is?an external one, notes the
Quarterly Update. Policymakers remain understandably concerned
about the over-investment that triggered the mid-year tightening
measures. "The lower investment growth that the authorities aim
for, which is desirable for efficiency reasons, could aggravate the
external imbalance if achieved without more consumption growth,"
says Bert Hofman, lead economist for China. "These considerations
put a premium on measures to boost consumption alongside those
already taken to reduce investment growth."
By "consumption" Hofman refers mainly to public spending coming
from the government in such fields as education, Medicare and
social security. Such spending would in turn lead to increased
consumption from people. "If individuals think the government is
taking care of them they'll spend more," Hofman said. He added that
increased expenditure on education nationwide currently in place
was a very good policy.
China's GDP growth slowed to 10.4 percent in the third quarter
from 11.3 percent in the second quarter after tightening measures
reduced investment growth. Exports continue to outpace imports by a
large margin so slowing domestic demand was partly offset by rising
contributions of trade to GDP growth while the current account
surplus reached new highs.
The Quarterly Update finds that macroeconomic prospects remain
favorable for growth. Prospects for a soft landing of the world
economy remain good although risks remain. China is relatively well
placed to deal with a mild global slowdown that would help to
arrest overall activity and reduce the current account surplus.
Domestically underlying conditions remain favorable to continued
rapid growth. The World Bank expects 2006 growth to be around 10.4
percent and it projects a slight easing of growth to 9.6 percent in
2007. Upside risks remain as investment growth may rebound with
abundant liquidity in the banking system and higher profit
growth.
Pressing problems are still in the way for China to achieve a
balanced economic structure with investment growth tilting toward
industry. "The underlying causes of high investment can be tackled
through better pricing of energy, resources, land and environmental
damage; higher interest rates; limiting retained earnings by better
corporate governance and an SOE dividend policy; and moderating
local government incentives to pursue growth."
Rebalancing the economy means a shift in production from
industry toward services, greater reliance on domestic demand, more
equally shared growth and more environmentally sustainable growth.
Besides being desirable in their own right, measures that support
rebalancing are also likely to address the surging trade surplus,
China's main short-term macro challenge.
The Quarterly Update notes that some measures have been taken in
this direction, notably the reduction in VAT refunds and
introduction of export taxes on energy intensive products, but the
report argues that these measures create new distortions as well as
address old ones.
Although macroeconomic risks appear manageable, continuing
mopping up liquidity remains necessary, the Quarterly notes, since
financial risks remain and excessive credit expansion may lead to
problems later. Abundant bank liquidity is at the core of rapid
credit growth. The apparent receding of non-FDI inflows implies
more room for monetary policy tightening although these flows
cannot be counted out. In addition to the liquidity creation
stemming from foreign exchange purchases, structural changes in the
financial sector are boosting M2 growth and may require additional
central bank efforts while in the short run liquidity will also be
boosted by higher government spending in the fourth quarter.
The current policy of some exchange rate flexibility around an
appreciating trend can bring about desirable expenditure switching
and create a welcome two-way risk that discourages speculative
capital inflows.
(China.org.cn November 14, 2006)