Millennium Post

Taming the downturn the Chinese way

A sudden slow down in China’s economy has created something of a scare among some experts. China’s economy has grown at its slowest of 7.6 per cent during the second quarter of the year. This is a sharp drop compared with 9.5 per cent a year back. In the first three months of the year, economy grew by 8.1 per cent.

Although much noise is being raised about the drop in growth numbers, the present growth rate is still very high for a major economy. Persistent growth at nine per cent and sometimes higher for the last decade has generated an expectation that the China should for ever be growing at that rate. It is but natural that with high growth, expanding the size of the economy, it should be increasingly difficult to grow at a fast rate.

Hence, the Chinese authorities have emphasised, right after the release of the figures, that the slow-down is a signal of the maturing the economy.

From this perspective, the current slow-down has two aspects. Firstly, the slow-down has been the result of a deliberate policy stance of the Chinese authorities. Secondly, the current slow-down is an effect of the global economic uncertainty and serious slide in the advanced economies. Let us look at these two factors in a little greater detail.

China had realised that the breakneck speed at which it was expanding would create serious bottlenecks and rigidities which should sudden clamp down on the economy. The option was between what is known as ‘a hard landing’ or a controlled slow-down. One aspect, which was very clearly visible in this context, was the property boom which was forming in China. Property prices had sky rocketed and it was clear that unless checked in time, this could boomerang.

To tame the run away property prices, the Chinese authorities imposed restrictions on purchase of second homes. Besides, indirect controls were also put in place to restrict demand for property. As China is still largely a command economy and commands are transmitted fast. Property prices began to come down and over time it has crashed. This has brought down investment in the real estate drastically.

A fall in real and housing sector has major implication for the entire economy and the contracting real estate and housing sector set in a spiral of slower growth in whole host of related sectors. Similarly, in the case of automobile sector, which had at times grown by no less than 20 per cent per annum, the expansion rate has slumped.

This was normal for an economy as too fast expansion puts stress on raw materials, environment, natural resources.

However the slow down has come at a wrong time. One of the premier China experts of leading global think-tank, Nicholas Borst of Peterson Institute for International Economics, has pointed out that the leadership transition in the country has created a situation when the Communist Party could ill-afford to have major economic problems on hand.

Borst writes that there is a ‘firm political floor’ under this year’s slow-down. That is, the leaders would try to make sure that GDP growth did not fall below a certain level and economic activity remained hectic. Without this, China would run the risk of social upheaval which could come in the way of smooth transition to a new generation of leaders.

For this purpose, China is already introducing expansionary measures. For example, they have driven down the policy interest rates twice in a month. They have also introduce ‘appliance purchase subsidy’ to encourage demand for consumer durables which is a major segment of Chinese manufacturing muscle. Some easing of real estate purchase rules are also being introduced.

Additionally, China still has a lot of fiscal firepower in reserve. China has introduced a new affordable housing scheme to ease rigours of property sector control on the margin. The amount of pump priming the Chinese authorities can introduce is also large, given that overall debt to GDP ratio is still favourable for China.

Experts feel that such stimulus measures can yet direct channelising investment funds into the bubble territory and unstable the economy in the long run. What is needed for the country is overall growth of consumption. This will call for fundamental restructuring of the economy. Chinese economic growth model has to be re-oriented from export led growth to domestic consumption led growth. However, some uncertainties and incentives still favour Chinese savings rather than consumption.

A basic condition for that to happen is extensive labour market reforms. Wages have been held down to subsistence levels for keeping Chinese products competitive in the global markets. Now is the time to change that and allow Chinese workers enough income to buy what they are producing for consumers elsewhere. The contradiction there is that Chinese goods will then become costlier and exports will suffer.

Secondly, China must also reform its exchange market. The policy followed so far kept the Chinese currency depressed against other major currencies. Its currency would now have to be more market determined. One advantage oft that will be that imports will become cheaper and thus help keep prices in the internal markets a low. Inflation fighting would become easier. The contradiction here is that this will leave its adverse impact on exports.

Thirdly, China has grown through over-blown investment. It made huge investments, created surplus production capacity and massive infrastructure facilities which have remained far from being fully used. Its productivity levels have remained low. China has so far grown through incremental investment growth rather than incremental productivity growth. This model will have to be changed to growth from productivity gains.  

These are difficult to achieve, and more so in the short term when the country is passing through a major political change. The dominant Indian view is that the Chinese authorities will continue to go ahead with short-term measures to keep growing at a fast pace rather than initiate steps for long term readjustments. The result will be to push the economy further intro potential much deeper instability in the future.
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