Economically Challenged

Some economists believe that the country's red-hot economic growth could slow down slightly this year. Yu Yongding, Director of World Economics and Politics at the Chinese Academy of Social Sciences, forecasts that China's gross domestic product (GDP) growth rate, which was 11.9 percent last year, will be around 9 percent in 2008.

Liu Fuxiang, an economics professor at the University of International Business and Economics in Beijing, said surging commodity prices might prevent citizens' willingness to buy and consume goods. The fallout from the U.S. subprime mortgage crisis along with the appreciation of the Chinese currency will add more pressure to export companies, even dealing some of them deadly blows. And frequent natural disasters, such as last winter's rough snowstorms in the south and the recent earthquake in Sichuan Province, are pushing consumer prices even higher, Liu told Beijing Review.

While a 2-percentage-point decline may not seem like much, it could affect employment. About 24 million new employees join the country's workforce each year. If the economic growth rate slows down, employment pressure will grow and pose economic and social uncertainties, Liu said.

Worsening inflation

Some economists say inflation could have a more immediate impact on the country's economic growth. In response, the government has promoted a number of policies to bring down consumer prices. Keeping the money supply in check is one of the most important policies. The central bank also has raised the reserve requirement ratio and interest rates frequently. Since 2007, it has raised the reserve requirement ratio 14 times and increased interest rates six times.

But inflation is still haunting the country. Data from the National Bureau of Statistics indicate the consumer price index (CPI) grew 8.2 percent in the first four months of the year. Meanwhile, consumer price increases are spreading from agricultural products to industrial goods. The producer price index (PPI), a barometer for inflation at the wholesale level, stayed at a low level for a long time but soared 7.2 percent in the January-April period. This was 4.1 percentage points higher than the PPI growth rate in 2007.
"Inflation is worsening," Liu said.

Apart from rising agricultural product prices, Liu believes the increasing money supply caused by a huge influx of foreign currencies also is a major driver of inflation.
Before July 2005, China had firmly pegged its currency, the renminbi, at 8.27 yuan to $1. The fixed exchange rate kept the prices of Chinese exports low, greatly stimulating international demand for products made in China. The rising level of exports had pushed the country's trade surplus to record highs. The fixed exchange rate and open economic policy attracted enormous amounts of foreign investment, making China one of the favorite countries for foreign capital.

The country's trade surplus and foreign investment were changed into renminbi through Chinese banks. The central bank had to print more money to buy foreign currencies, because the renminbi cannot be freely converted into other currencies. The increased money flow pushed inflation even higher. Although the country has had a floating exchange rate since mid-2005, the renminbi's slow appreciation against the U.S. dollar has not changed China's high trade surplus and foreign investment level.

Yu Yongding contends in his May 12 research report that inflation has not been the only monster that people are worried about. They are much more concerned about inflation expectations that directly influence the activities of producers and consumers and can lead to price hikes, hoarding and cornering supplies-all of which, in turn, worsen inflation.
Yu said the international economy is facing inflation pressures, and nearly all commodity prices are surging rapidly. The food price hikes have caused panic in some developing countries. The prices of base metals also keep rising significantly. The international environment adds fuel to Chinese inflation, he said.

The American factor

The U.S. economic recession caused by the subprime mortgage crisis would diminish its citizens' demand for Chinese products and drag down Chinese exports, Yu said. Exports are considered one of the three pillars of China's economy. A decrease in exports would have a negative impact on the country's economy.

The devaluation of dollar assets has caused direct losses for Chinese financial institutions, Yu said. The massive foreign reserves the country has accumulated over the last couple of decades are quickly depreciating. The U.S. Federal Reserve's policy changes magnify the difficulties of China's macro-control policies.

But worse still is that the U.S. recession is pulling down China's economic growth, Yu said. The American recession also would exert negative influence on economic growth in other countries, further decreasing their demand for Chinese products, he said. The shrinking exports would directly pull down GDP growth, investment and imports needed for the processing trade sector, the backbone of the country's overall exports and imports.

Yu said his institute is now estimating the U.S. economic recession's impact on China's economy. The preliminary conclusion is that China's GDP growth rate would drop 0.94 percentage points if the U.S. economic growth rate slowed down 0.7 percentage points as the International Monetary Fund has anticipated.

Yu also said the renminbi's appreciation against other major currencies would have negative effects on China's economic growth. He estimates that if the renminbi appreciates 10 percent this year, the growth rate of China's net exports would drop to 25 percent. Under such a scenario, the GDP growth could drop 2 percentage points.

"Coupled with the decrease of net exports and consumption, Chinese economic growth will be seriously exacerbated," Yu said.

Policy dilemma

On May 20, the central bank raised the reserve requirement ratio for the fourth time this year to 16.5 percent.

In 2007, the government decided to maintain a stringent monetary policy to cope with inflation and the overheated economy. But the money liquidity in the market did not seem to be influenced by the frequent controlling measures. Data from the central bank's May 13 report indicate that market liquidity was still sufficient. The balance of loans of financial institutions stood at 29.86 trillion yuan ($4.27 trillion) by the end of April, up 16.13 percent year on year.

Another monetary policy problem stems from the renminbi's appreciation. The currency's fast appreciation since the beginning of the year has had clearly negative impacts on Chinese exports, putting many domestic factories in dire straits. Many exporters are against the renminbi's continued appreciation, while some even have suggested that the government resume the pegging mechanism.

Yu has other concerns. He said the devaluation of the U.S. dollar and worsening inflation in the United States have turned the yields on U.S. treasury bonds negative. China is losing much in the international economic marketplace, he said.

While China is raising interest rates, the United States is cutting them. Expectations for the renminbi's further appreciation has attracted more international speculative money, adding more pressure to the country's monetary policy, Yu said.

Financial decision makers in China are brainstorming on what the country should do next. To improve the situation, the government must quicken its pace in reforming foreign exchange mechanisms by increasing the flexibility of foreign exchange as a tool for combating financial problems, Liu said. It also should maintain a stringent monetary policy to curb demand for cash and inflation, expand government expenditures and indirectly promote individual consumption, he said. Liu believes this is the best way to ensure a soft-landing for the Chinese economy.