As the international financial crisis further intensifies and the global economic environment deteriorates, more signs of slowdown in the Chinese economy appear. In particular, China's third quarter GDP growth has decelerated further. Under these circumstances, objectives of government economic policy have undergone fundamental shift. This article attempts to assess the prospects of the Chinese economy and its policy changes.
Changes in Economic Trends and Environment
China's year-on-year quarterly economic growth has decelerated gradually after reaching a peak of 12.6% in Q2 2007. In the first three quarters this year, economic growth rates were 10.6%, 10.1% and 9.0% respectively. The period average was 9.9%, 2.3 percentage points down from the same period last year. The particularly substantial decline of growth in Q3 by 1.1 percentage points has given rise to worries about the coming of a more drastic economic slowdown.
This year, exports and fixed investment have led the fall in China's GDP growth rate. In the first three quarters, exports grew by 22.3%, 4.8 percentage points down from the same period last year. Taking into consideration the 5% depreciation of the USD against the RMB, actual growth would even be lower. Trade surplus for the period shrank by USD4.7 billions, or by 2.5% (last year it rose by 69%). Its contribution to GDP growth has turned negative. As to fixed investment, its growth in the first three quarters averaged at 27%. Though this was higher than last year's 24.8% growth, taking into consideration the rise in related prices (10.3% vs. 3.9% last year), real fixed investment growth should register a decline, particularly for real estate investment.
Among China's economic sectors, industrial production has recorded the largest decline in growth. For example, value-added of the industrial enterprises above designated size grew by 15.2%, 3.3 percentage points down from same period last year, with growth in September down to 11.4%, seemingly suggesting a downward trend. Apart from the possible impacts from the Olympic Games in a few provinces, there are several reasons for such performance. These include the deterioration of the external trade environment, the fall in profit growth (falling by 17.6 percentage points to 19.4% in the first eight months this year), and the rapid cooling of the domestic real estate market, causing the steel and cement industries to suffer.
It can be seen that both external and internal changes have contributed to the cooling of the Chinese economy. Externally, it is the global economic and financial shock led by the U.S. subprime crisis. Domestically, the adjustment in the real estate market has played a major role. Overall, the deterioration of the external environment should be the fundamental cooling factor, as this has not only affected China's exports, but also investors' expectations, adding pressure on the already weakening real estate market.
Private consumption has so far performed well in China, as reflected in higher retail sales growth in both nominal and real terms. Nevertheless, there were caveats. Firstly, real per capita consumption of urban household grew only by 5.7% during the first half-year, much lower than the 11% in the same period last year. Compared with retail sales, this may be a better indicator of consumption. Secondly, consumer confidence has shrunk. Thirdly, income growth has also decelerated, down to 7.5% year-on-year in the first three quarters, compared with 12.2% last year. Further, the worsening employment prospects amid falling exports and the negative wealth effect created by adjustments in the stock and property markets should warn against over-optimism about consumption.
The Shift in Policy Objectives
As the economic environment deteriorates, China's macroeconomic policy has also made fundamental adjustments. The major objectives have gradually been shifted from last year's prevention of overheating and inflation, to sustaining growth but containing inflation earlier this year, and recently to maintenance of stability in the economy, financial and capital markets, and the society. In the latest shift, especially since October this year, various measures have been implemented, including the lowering of interest rates and the deposit reserve ratio, raising export rebates for nearly 1/4 of the exports, trimming down-payment and transaction fees for real estate purchases, and etc. The State Council said it will consider specific measures in taxation, credit and trade during mid October, with emphasis on "propelling investment growth" - the first time since 2004 when the government started to introduce measures to rein in investment growth.
In short, China's economic policy has become expansionary, both in fiscal and monetary aspects in general, and for specific areas (like exports, SMEs and real estate), after emphasising on tightening for a few years. This is a necessary response to the drastic changes in both domestic and external economic environment. More accurately, without any systemic crisis so far, China's policy shift is mainly precautionary in nature, in contrast to the need to rescue the markets or the economy in other countries. As it takes time for the international financial markets to recover, the global economy will further weaken, adding pressure on the Chinese economy. Therefore, China will certainly continue to make efforts to support the economy.
China's Outlook
Amid changing economic environment and shifted policy objectives, there are three major favourable factors for China. Firstly, as China's capital market remains largely closed, the financial sector is still traditional and inward looking, with limited connections with the global markets. This would prevent China from being directly affected by overseas market turbulence. Secondly, there is much room for accommodative policy, for example in lowering interest rates and the deposit reserve ratio which have been raised to relatively high levels, and in credit that has been tightened. Besides, China's fiscal revenue has grown substantially during the boom years, helping to lower the deficit to GDP ratio to 0.8% in 2007, much lower than the 3% widely recognised critical level. This should provide much room for the Chinese government to stimulate the economy through various fiscal measures, e.g. increasing infrastructural investment, lowering taxes or granting subsidies. Thirdly, inflation is currently moderating, with the CPI growth fallen to 4.6% in September from the peak at 8.5% in April. Though PPI increase was still high at 9.1% in September, it has also come down from 10.1% in August. As commodity prices have fallen substantially in anticipation of a global economic slowdown, China's inflationary pressure would be further relieved, giving further room for stimulating measures.
Nonetheless, it should be noticed that the current changes in China's economic environment are by no means short-term. The international financial crisis is still running its course, spreading from the U.S. to Europe and Japan, and eventually to the emerging markets. It is disastrous to the international financial order. It causes the global equilibrium built on reliance upon the debt-financed U.S. consumer demand to break up. Re-adjustment would take much time. With nearly 40% of GDP made up of exports, China will face continual pressure. Domestically, the Chinese economy has entered the downward cycle after enjoying high growth for a few years. The surge in inflation last year has already signified the resources restraint to high growth while the cooling down of the real estate market should represents adjustment to bubbles. These internal and external trends are both cyclical as well as structural, and their impacts are likely to linger on.
Therefore, the downward trend of China's economic growth can be recognised, with Q2 2007 as the peak. As China is still in the process of industrialisation and urbanisation, together with the government's capability to implement expansionary policy, it is expected that economic slowdown would be moderate and gradual. Growth in the fourth quarter is likely to rebound, in light of the recent bulk of measures. However, as the global economy is likely to further adjust, and will continue to affect China's industries, investment and employment through weakening external trade, the Chinese economy is expected to slow down in 2009, growing by about 9%.
Problems and Risks
While official policy plays a major role in sustaining China's economic growth, a number of issues deserve our attention.
1. Investment or consumption? To stimulate the economy through domestic demand, it is much simpler to increase infrastructural investment. Boosting consumption, on the other hand, would be more complicated and take more time to be effective. Yet, consumption remains the crux of domestic demand, essential to digest the excess capacity. Its performance would also determine China's long-term economic development. Currently, the government has inclined to boost the economy initially through investment. Though this is more effective in the short-term, related problems should be attended to. In terms of financial resources, boosting investment would undoubtedly reduce the capability to improve social welfare, which would be crucial to people's spending power and desire. In other words, propping up investment may crowd out consumption. Besides, should various provinces increase investment at the same time, it may be result in resources shortage and cost-push inflation, or lead to additional pressure on excess capacity. Hence, whether sustaining growth can be effective depends much on the ability to strike at the optimum composition of investment and consumption measures.
2. Sustaining growth and economic restructuring. To avoid abrupt economic slowdown in China, measures to stimulate exports and investment are deemed necessary. This, however, may lead to conflicts with the goal of economic restructuring, for example in the upgrade of trade composition, shift from external to internal growth drivers and from investment to consumption. These efforts to restructure may need to suspend. Nevertheless, in light of the long-term nature of the current economic adjustment, the way to sustain growth needs more thorough consideration. Some "baselines" have to be set when devising stimulating measures, e.g. in environmental protection. It would be much better to foster restructuring through economic self-adjustment. This would favour China's economic health and better fit its long-term need in facing external challenges.
3. Pros and cons of the rescue measures. As the real estate market has been a major driver of the recent economic boom, measures to support it are actually supporting the economy. Similar to measures in other areas, there are doubts to their effectiveness as well as risks. The crucial thing is whether these can change market expectations, especially when bubbles are still recognised to exist. If measures are not effective, market confidence may shrink further. They may also be effective only in the short-term, but fail to alter the long-term declining trend. Investors should bear this in mind, while policymakers should fully take the issue into consideration
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