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China economic outlook: a tighter macro stance and renewed focus on structural reform

Louis Kuijs's picture

We just released our China Quarterly Update. For us (the economics unit in the World Bank’s Beijing office), this is a good disciplinary device to go through the data, look at what has happened, think about what the economic prospects and policy implications are, look in some more detail into some issues, and write it all down.

In addition to the usual topics, this time we focused a bit on two macro risks that have caught the attention of analysts: a property bubble and strained local government finances. In this blog I summarize our current understanding of the general economic outlook and what it means for policymaking. In a separate blog post, I will soon discuss the issues on local government finances.

China’s economy has held up remarkably well during the global recession. GDP grew 8.7 percent in 2009, led by a massive investment-led stimulus that showed up partly in an increase in the official fiscal deficit and, especially, in an increase of net new bank lending of almost 30 percent of GDP in 2009. Real estate investment gained prominence more recently.

Through all this, household consumption growth has remained solid, in no small part because the labor market held up well. It is not easy to have good timely labor market indicators on China. But I like the quarterly income data from the household survey.  Per capita rural wage income growth, which includes the impact of both wage and employment developments, dropped sharply to 7-8 percent (yoy) in the last quarter of 2008 and the first quarter of 2009. But, as the economy picked up again, it recovered quickly, reaching more than 13.5 percent (yoy) in the second half of 2009. This confirms more anecdotal indications that the trough in the labor market was quite shallow and short.

Exports declined an estimated 10.6 percent in 2009 as a whole, even as China gained global market share. With imports holding up much better than exports, net external trade was a major drag on growth in 2009, subtracting 3.9 percentage point from GDP growth, and the external current account surplus declined from 9.4 percent of GDP in 2008 to 5.8 percent of GDP in 2009. The higher frequency data shows a dramatic shift, though. After falling steeply in late 2008, exports rebounded strongly through 2009 and in early 2010 they already exceeded the pre-crisis level.

The growth momentum continued in the first months of 2010, with particularly strong exports, retail sales and industrial production. Building on this, GDP growth is likely to remain strong this year. We project 9.5 percent. However, the composition of growth is set to shift markedly in 2010. 

  • Exports are on course to grow robustly, as global demand recovers, even though forecasts for world trade for the year as a whole imply a slowdown later in 2010. Although imports should outpace exports somewhat, we project a mildly positive contribution of net external trade to growth this year, which is a large improvement compared to last year (Figure 1).
  • However, real investment growth may be around half of the rate last year (Figure 2). In a heated housing market, real estate investment should grow strongly. But, government-led investment, the key driver of growth in 2009, is bound to decelerate heavily.
  • With labor market conditions favorable, we expect consumption growth to remain robust, even though sales of consumer durables, notably cars, are likely to decelerate after the spectacular, partly policy-induced surge in 2009.

On other aspects, in our scenario the trade surplus edges down in US dollar terms  because of an expected decline in the terms of trade. The current account surplus may increase somewhat, though, in US dollar terms, though, mainly due to higher income on China’s foreign reserves.

Inflation is likely to increase. But, we think inflation will remain modest—maybe reaching 3.5-4 percent on average in 2010—because international inflation prospects are subdued; the China-specific factors behind food price increases are unlikely to persist; and China’s rapid supply response is likely to continue to contain core inflation.

However, in a heated real estate market, property prices are rising rapidly. In large cities they were on average more than 30 percent higher than a year ago in February, and further increases are in sight. This has triggered policy measures to expand supply and curb speculation, although the government is cautious in its policy response and does not want to clamp down on real estate to heavily.

The world economy is still subdued, but China’s growth has been strong. Unlike in most other countries, China’s output is close to potential (Figure 3). Thus, China needs a different macro stance than most other economies. We think that inflation risks remain modest, in large part because of the global context. But, the macro stance needs to be noticeably tighter than in 2009 to manage inflation expectations and contain the risk of a property bubble and strained local government finances.

  • The budget presented to the National People’s Congress (NPC) rightly implies a broadly neutral fiscal stance. The 2010 budget presented to the NPC foresees a broadly unchanged budget deficit, compared to 2009. However, there are still uncertainties about the world economy and it is important to have flexibility in implementation. We think that means contingency plans and, importantly, letting automatic stabilizers work.
  • The monetary policy stance needs to be tighter than last year and the case for exchange rate flexibility and more monetary independence from the US is strengthening. It would also be good to increase the tolerance for modest inflation, to ensure room for needed relative price changes. In our view, strengthening the exchange rate can help reduce inflationary pressures and rebalance the economy. Over time, more exchange rate flexibility can enable China to have a monetary policy independent from US cyclical conditions, with is increasingly necessary.
  • Ensuring financial stability includes mitigating the risk of a property price bubble and ensuring the sustainability of local government finances. This calls for both macroeconomic and other measures. The Quarterly discusses them.
    Sustained, sustainable growth requires structural reforms. In the presentations to the NPC, the government emphasized the need to adjust the structure of the economy. With growth prospects good and China preparing for 12th Five Year Plan, this is a good time to both look at the whole structural reform agenda and to select those that can be advanced in the short term.  The Quarterly provides an overview of the key areas of reform.

Comments

Submitted by Hao on
Your writing is proper as always. I think the government has done an excellent job to support China's growth measured in number, though the expansion in output is largely "uneconomic". They have long been foreced and urged to boost the economy. A hard job. But what I expect in your quarterly update (actually also an excellent job) is more than why China has grown and how it will. If the World Bank really cares about the sustainability of China's economy, it should listen more to the bank's former advisor, Herman Daly. I hope you could update us more on what costs China has paid for such "wonderful" growth.

Hao, Thank you for your comment. You mention that recent growth in China is largely "uneconomic" and costly. I am not fully sure that I know mean, but I will try to comment. To my shame I did not know Herman Daly's work. But I googled him and I found out he is a specialist in Ecological Economics. There are potentially 2 types of costs stemming from China's rapid recent growth. The first one is costs to the environment and resources that make the growth unsustainable. I think that, looking back on the last, say, 10 years of phenomenal growth, this type of growth cannot be sustained over the next decades without large scale environmental degradation. Thus, I strongly hope, and also believe, that the government will be able to make enough progress with rebalancing the pattern of growth, to make growth more environmentally sustainable, but also address some of the other imbalances that have come hand in hand with China's growth, such as increasing inequality. This rebalancing was a major objective of the current (11th) Five Year Plan. I think important first steps have been made in many areas. But, this clearly is an unfinished job (this 2 sided conclusion was also the conclusion of a mid-term evaluation of the implementation of the 11th 5 Year Plan that I coordinated: http://siteresources.worldbank.org/CHINAEXTN/Resources/318949-1121421890573/China_11th_Five_Year_Plan_main_report_en.pdf). I hope and expect that the rebalancing will continue to be pursued during the 12th Five Year Plan period. Economic growth often creates pressure on the environment, but this is particularly the case when resources and the environment are not rightly priced. That is why getting prices right and removing subsidies for industry, implicit and explicit, is so important. The second potential type of costs of the recent growth, particularly the growth in 2009, could be investments that will turn out not to be economically viable. In particular, there are concerns that some of the infrastructure investment carried out by local government investment platforms will not generate enough returns to repay back the loans. This may well be the case. Of course, some infrastructure is not built in order to generate more financial return or more economic growth, but in order to improve the quality of growth. This is true for instance for waste and waste water management facilities, sewage systems and other second generation infrastructure that we have seen more of recently than in the past. But what would be particularly problematic is if infrastructure such as roads and bridges are built that are not used and that do not over time generate growth and revenues. There is always a risk this happens, and history has many examples. However, I would say that China actually scores quite ok on this front. By and large, the infrastructure in China ends up being used and helps development. In all, I take your point that for various reasons economic growth may be uneconomical and costly. Looking ahead, this actually poses an important question. What would be a sustainable rate of growth. Economists--me included--love to talk about "potential" growth. However, this is actually a narrow concept, which says something about the capacity to produce and how fast a country can grow without running into macroeconmic problems. As China is preparing for the 12th 5YP, and as the government is emphasizing not just the pace of growth but also the quality of growth, determining a sustainable rate of growth is one of the key tasks ahead.

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