There is a broad belief that China is the only economy that can cushion global output during our current period of turbulence. If this belief is to be realised, China must maintain fairly strong growth in output. It has grown by over 10% per annum for half a decade, but growth has now slowed to 9%. This level is spectacular when we compare it to developed economies, but it needs to be at these levels and higher to reflect real economic growth.
The Chinese Government deliberately set out to slow economic growth in early 2007 by means of interest rate increases to stem a rapidly increasing inflation rate, and a totally overheated equities market and property market. The goal was achieved, but unfortunately it coincided with a dramatic slowdown in the world economies, and as a result it has experienced a substantial reduction in demand for steel, construction, electricity, cars, travel etc. Industrial production fell to half the level it averaged over the previous five years. If this trend continues unabated, the GDP growth for next year could drop to as low as 6%.
Unlike the developed economies, China’s population is not drowning in debt and as a result falls in asset values do not hurt them nearly as much as they hurt others, particularly in the USA. Also Chinese incomes have risen by as much as 14%, which will help sustain spending and retail activity.
The Chinese Government has a strong desire to maintain growth at levels above 8%, as it cannot afford to see unemployment rise because it would lead to social unrest. It has led its population down the path towards capitalism and must make the transition succeed.
It has been taking concerted action to insure that growth continues to occur in its economy. It cannot control what happens outside its borders but it certainly has the capacity to activate what happens internally. Interest rates have been cut three times since tightening stopped earlier this year; strict controls on bank spending have been removed; minimum deposits on mortgages have been reduced; mortgage rates and transaction costs have been reduced. Finally a planned surge in infrastructure spending will result in a far more important boost to growth.
A 4 Trillion Yuan spending package has been approved. This will be spent on public housing for the poor, infrastructure such as roads, rail, airports, earthquake rebuilding, the power grid, education, health, tax reform, capital equipment upgrade incentives, farming produce price incentives and farm subsidies and social security benefits. The total increase in investment is expected to be over 8% of GDP for two years.
Unlike developed economies, where incentives are being directed toward consumption through tax cuts, all incentives are focused on infrastructure investment, as any consumption incentives would be immediately transferred to household savings (as that is the Chinese way). In the longer term, as the economy matures there will be more emphasis on consumption expenditure.
Another significant characteristic in the Chinese economy is that the banking sector has avoided the problems that have blocked credit markets in other economies, and unlike other economies total bank lending has fallen relative to GDP since 2004. Business loans are mainly to industries outside property development which have strong profit margins and low debt. The banking sector is also state controlled and can be instructed to maintain the required lending volumes to companies.
If the Chinese economy successfully achieves its target growth rates of 8 to 8.5% it will account for half of the increase in world output next year. This shows how significant China is becoming and how significant it will be as it matures economically.
If this stimulus package is successful, China will guide its economy through the current rough period and avoid a hard landing. At the same time it will help the world economy by drawing in raw materials and machinery from the rest of the world, particularly Australia.
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