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Monday, April 16, 2012

The Chinese Economy: Slowdown for the Sake of Future Growth

In addition to the artificially lowered exchange rate and interest rate, the Chinese economy faces other structural problems and well explore them in this post. Here well also explain why the Chinese authorities are treating the current slowdown as an opportunity to restructure the economy for future growth.

Problems in the Financial Market 

China’s currency Renminbi isn’t freely convertible and foreigners are often denied access to the currency. The process of internationalization has just started. Besides, the major Chinese banks are still controlled by the state and have to fulfill policy goals instead of putting profitability and shareholder value as the top priority.

For example, in response to the financial crisis, the state banks loosened credit more than private banks run on market principles would optimally do, because they had to help the central authorities to stimulate the economy. This prevents the efficient allocation of capital, and also increases non-performing loans ratio at state banks. These aren’t the features of a mature, sophisticated market economy.

(Comment: Another problem is the lack of competition in China’s financial market, as Premier Wen told the press earlier this month. Besides, the rich and the powerful with connections to bankers and public officials have much easier access to credit. This again makes capital allocation inefficient and undermines the fairness of the financial system. Reforms are needed but they’ll have to face fierce opposition of the vested interests.) 

Fear of a Hard Landing 

Given the above problems, together with the downturn in China’s real estate market and the European debt crisis (which hurt Chinese exports), some observers already worry about a hard landing in China, though its economy isnt as highly leveraged as the U.S economy.

(Comment: The Guardian published a debate between Andrew Batson and Patrick Chovanec on whether China will face a hard landing this year. A professor at Tsinghua University, Chovanec is an active blogger and an expert on the Chinese economy. His blog features a brilliant analysis of the downturn in China’s real estate market.) 

Restructuring to Pave Way for Future Growth 

You may wonder why the United States can enjoy a high credit rating even when the country owes so much debt, while China can’t. Some Chinese may think this is a conspiracy: the credit rating agencies, which are mainly run by Americans and Europeans, are biased towards America. However, the truth is the American economy can support a bigger size due to its sound economic structure, while the structure of the Chinese economy isn’t as efficient or robust.

The Chinese authorities are well aware of this. That’s why they’d rather slow down the economy than to push for higher growth in the short term. It can be foreseen that, to improve the health and stability of its economic structure, China will try hard to shift the growth engine from investment to consumption in the next few years, with the help of a higher interest rate as well as other policies.

(Comment: Despite the unfavorable conditions, I believe the Chinese economy probably wont suffer from a hard landing. As a report titled “Growth Worries” from the Economist Intelligence Unit suggests, even if the economic slowdown is more severe than expected, the Chinese authorities can carry out fiscal expansion since they aren’t debt-laden like its Western counterparts.

Indeed, the capacity for fiscal stimulus should be high, given that the heavy local government debt, a chronic problem in China, appears to be under control. Besides, since inflation has fallen to below 4% this yearthere is room to inject money into the economy and lower the interest rate, though this is contradictory with the long-term goal to rebalance the economy.)

(Entry 3 of 6 in The Global Economic Landscape in 2012 series)

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