China's economic prospects in 2009

In 2008, the world economy was rocked by the financial crisis that had its roots in the United States. The set-up of China's financial system had isolated it from the worst of this crisis, but it has not been spared the effects of the world economic downturn. Will this mark the end of China's double-digit growth? World Bank senior economist Louis Kuijs spoke with Radio86 from his Beijing office about what awaits China in 2009.

Radio86: Have we passed that period of the financial crisis? Are we now in an economic slowdown?

Kuijs: Definitely, there's no question about that. It's now more than a year ago that the first problems started to emerge in the US and for a long time, from a Chinese perspective, there wan't much pressure on China's own financial sector. But as the economic impact started to be felt in the economies around the world and especially in emerging markets as well in October 2008 or so, China is beginning to feel its impact.

Emerging markets around the world are now facing a funding squeeze, a squeeze that prevents their growth. These countries are very important clients for China's exporters, they buy more than 50 percent of China's exports. When virtually all of China's partner countries are facing downward economic pressure, that clearly has translated into a real economy problem in China. We're seeing that virtually all economic indicators are moving in a downward direction at the moment. This is definitely an economic issue.

Do you think China's initial reaction to the financial crisis and what they're doing now is beneficial? How prepared are they for the coming economic slowdown that came from that financial crisis?

I think that China's policymakers realized from the beginning that China's financial system was not going to feel a lot of direct impact from the international financial problems. China's financial system and its banks are pretty insulated from what is happening with toxic US assets and other highly sophisticated products that were sold in New York. China's banks simply didn't own many of these things and China's financial system is operating behind capital controls. It's not easy to bring capital in and out of this country, so its financial system didn't feel a lot of direct impact,

Of course, China's real economy is very integrated in the world economy and therefore China's real economy feels a lot of impact. We think that the best way for China to respond to this is more or less along the lines of what the authorities are trying to do. They're right to focus on keeping up overall domestic growth by trying to boost the domestic economy to offset the negative impact from that weaker external environment through more domestic spending and more expansionary fiscal and monetary policy inside China to ensure that overall growth keeps at a decent pace in this more depressed external environment.

In its last quarterly report, the World Bank mentioned that it considers China to have strong macroeconomic fundamentals. What does that mean?

China doesn't have an external problem in the sense that China saves more than it invests. That means it doesn't rely on the outside world to finance its growth, that's a very important aspect of macroeconomic fundamentals. China's fiscal position or the position of the government is strong in the sense that it has seen rapid increases in revenues that basically mean that the central government has a buffer. It can now spend and boost growth by spending without being concerned that, say, the financial markets don't want to hold China government bonds because they're afraid that the government cannot repay back its loans. On many of these issues – the external position, the fiscal position and these indicators of macroeconomic stress – China scores quite well and therefore we think that China's macroeconomic fundamentals are strong.

How does China's foreign currency reserves play into this?

The foreign currency reserves are a result, if you want, of this strength. Everybody knows that China has grown rapidly, but it has grown in a way that is macroeconomically quite sustainable. China has seen rapid increases in investment but all of that investment has been financed domestically. That means that in addition to financing the investment, China, as a country, has ran a current account surplus, meaning that they're saving more than they invest.

In addition to some additional capital inflows, these external surpluses are accumulating as foreign reserves. The foreign reserves are a result of a fundamentally sound way of growing. These reserves, of course, are a buffer in difficult times and that is why not many people would be worried that China can not pay its external bills.

What is the World Bank projection for China's growth in 2009 and what factors were taken into consideration when making this projection?

While we are looking at China's economy, we also look at the world economy, the world financial system and the problems that they are going through at the moment. We are not that optimistic about the general state of the economy in 2009 for the world. In this fairly subdued international picture, our forecast for China foresees a GDP growth of about 7.5 percent for 2009.

When we communicate our views and forecast to people here in Beijing, they are very disappointed because they feel that China should be able to grow by at least 8-, but preferably by 9- or 10 percent. In China, the expectations for what the economy and what economic growth can deliver are actually quite high. Especially in the last five to six years, people have become used to double-digit growth rates.

Louis Kuijs is a senior economist at the World Bank in Beijing (Image: courtesy of L. Kuijs)The government also feels that when growth is coming down to 8- or 7 percent that that could really be a concern. One thing that makes China stand out from, say, European countries or the US, is that the country as a whole is still quite poor, so China needs this growth to sustain improvements in living standard and to create jobs, among other things.

There are concerns that a low growth rate in China would breed social unrest, do you agree with that?

That is what the government thinks. The government feels that if growth comes down to below 8 percent, then not enough jobs are created in the cities and that may lead to things including social unrest. We understand this concern, but we also feel that not all growth is the same. A more labor-intensive service-sector oriented growth could deliver more jobs even at a lower rate of growth.

Social unrest in China has an almost economic connotation, a connotation coming from the fact that most types of social unrest had economic causes. They could be related to property disputes or layoffs. At the moment, we are seeing many local governments considering how they should deal with layoffs and other dislocations from the economic downturn. We tend to say that one way to deal with this is to try to keep up growth by more government spending. Another way is to use the social safety net to make sure that those people who are temporarily laid off could pick up some minimum living allowance and therefore continue their existence without the kind of problems that they would otherwise have.

We understand the government concern about social unrest. We do think that China is probably as well-placed as any other emerging market to deal with that. I wouldn't take the concerns about social unrest too much in the direction of this is a political concern, or that this will take systemic proportions.

In the last quarterly report, there were also several references to China's need to rebalance its growth. Why is there a need for this?

I was saying earlier on that I feel China, in a kind of narrow macroeconomic sense, has seen very successful performance over the last 15 years or so. But if you start to look a bit wider and you start to look at things like environmental sustainability or urban-rural inequality or external imbalances, then there are a few dimensions on which growth was not very balanced. The government has noticed that as well and would like to rebalance growth in that sense.

The kinds of policies that would help move in this way are those that can increase the importance of the service sector in the economy and that can stimulate labor-intensive growth in the cities. They include pricing policies so that it becomes more attractive to produce services in China's economy. That means taking away some barriers and improving the internal terms of trade as we call it. It also includes fiscal policies as well as labor market policies that make it easier for people to migrate to the cities and actually live there and have their children be educated in urban schools. It includes financial market reforms. There's a pretty broad package of reforms that we think will help push China in the direction of rebalancing.

What are the three biggest challenges that China has to face within the next year and what steps has the government taken to minimize the impact of the slowdown on the ordinary citizen?

Growth could disappoint. So the challenge is to keep up growth by conducting expansionary fiscal and monetary policies without going overboard. Governments run the risk of adding too much fuel to the fire or of mistiming when they are trying to boost spending. If you do it too late, then you are boosting spending at a time when the economy is already in a recovery. The first challenge is to boost growth and to make sure that growth remains decent.

The second challenge would be that there are now such a lot of demands on policy making and on boosting growth in the short term that there is a risk that some of the spending is not going to be very effective or mischanneled in the wrong direction or areas. There are risks that policy making, which is now so much in a hurry and on which there is so much pressure, makes some mistake.

There is also a trade-off that needs to be made between working on meeting the short-term objectives on the one hand and working on meeting the long- and the medium-term objectives on the other hand. So another challenge is to balance these two. It is easy to forget about the medium- and the long-term objectives if you are very focused about today's concern such as how to boost growth. It remains important to keep the long-term development objectives in mind on the one hand and also to keep the medium-term rebalancing objectives in mind on the other hand and to balance whatever you do in the short term with the need for those medium- and long-term objectives to also be achieved.

It has been said that the ordinary consumer in China holds the solution to the economic crisis. That they should spend more rather than save as the Chinese are wont to do. What's the best way for the government to stimulate consumer spending in these times of economic turmoil?

I think it's right to say that over the medium term we need to see more consumption in China but what you are pointing out is something we would also subscribe to, that you cannot just expect this whole rebalancing, this whole increasing the role of consumption, to be done on the back of people starting to spend more money. It would not be a sustainable way of getting this rebalancing done. It would have to be done in a way that will also boost these people's incomes.

What we need is to see more jobs in the urban areas, and more people with decent incomes from working in productive sectors of the economy so that they can sustain the spending year after year. Sometimes people have looked at this rebalancing issue and they notice that China doesn't consume a lot and they say, “Oh, let's just hand out credit cards and let people consume.” That is really not going to work. This rebalancing is a medium-term process and it would have to be done in a way that is financially sustainable. Therefore I think your concern is right. We cannot really expect consumers to start to spend money, especially not if confidence is hit.

"Once people have jobs, they have a stable livelihood and can start to think about spending their money," Kuijs says. (Image: Radio86)Financially sustainable and economically sustainable ways to boost consumer spending will have to involve beefing up people's incomes, and the role of wages and household incomes in the economy. That's why we hammer so much on this issue of getting more growth from the service sector, which is a relatively labor-intensive sector in the sense that surface sector activity creates jobs. Once people have jobs, they have a stable livelihood and can start to think about spending their money.

This is a medium-term issue that cannot be done by boosting people's consumption in isolation. The boost to consumption will have to be part of a more general structural change in the economy that allows for more labor-intensive urban activity as opposed to the more capital intensive industrial kind of growth that we have seen so far.

Compared to the US and countries in the Eurozone, how do you think China will fare in the next two years? Does it have more room to maneuver?

China has unambiguously more room for maneuver than many other countries. There is a little bit of an irony at the moment: When you look within the Western world, it seems that the countries that are most stretched and that face the largest challenges in their economy like, for instance, the US and the UK, they are the ones that are very keen to boost fiscal spending, to increase the deficits; whereas others -- like Germany -- that are not as stretched in that sense, are much less keen to do this. So there is some tension, there are different approaches within the Western world on how to deal with that.

China is very keen to use the room that it has to boost fiscal spending and also to ease monetary policy. I think it is pretty unambiguous that China will see more growth in 2009 and 2010 than most other parts of the world, even though that may still be a disappointing outcome for China itself, coming on the back of 12 percent growth in 2007.

Is there still pressure from the international community for China to step up? In the beginning of the crisis, everyone seemed to be looking to China to step in and stop the world economy from collapsing.

We think that by and large the best thing that China could do, the most important contribution that it can make to the world in the current circumstances are: First, to make sure that growth in China's economy is growing at a decent rate because that is good for the world economy. Second, to make sure that China's markets remain open and to make sure that we're not going into an area of trade protection. It is very important for China to keep its markets open as it continues to grow faster than the other parts of the world. I think that so far China has been doing well on these two fronts. The government is quite committed both to boosting growth and also to keeping its own domestic trade liberalization going and also to remain a positive force in the world multilateral trade negotiations.