In 2007, China marked its fifth straight year of double-digit growth. But with the world economy threatened by a credit crunch and showing signs of a slowdown, will China's growth be negatively affected?

"China had another strong year, with a strong growth in exports in particular and investments. The country is generating a lot of jobs and in general, China's macroeconomic position has remained pretty strong," Louis Kuijs tells Radio86. Kuijs, who has held the position of senior economist for the World Bank's China office since 2004, is the main author of the China Quarterly Update.

China was not totally untouched by the negative developments in world economy, Kuijs says, pointing out that at the end of 2007, its economy showed a bit of a slowdown.

"Chinese exports went down during the latter half of the year, but Chinese imports strengthened during that period. That seems to be consistent with the picture of the world economy slowing down somewhat and affecting China. At the same time, the domestic economy in China has remained very strong and that has offset some of that external weakness. That's why overall growth remained solid even at the end of the year, despite some slowdown of the world economy."

Inflation could become a concern

It can be quite tempting to focus on China's economic and gloss over the problems that the country could experience. One monster already rearing its head is inflation.

"Inflation is running at about seven percent at the moment. So far, that is almost purely driven by higher food prices. We have not yet seen a lot of spillover of those high food prices into more generalized inflation pressures, but that doesn't mean that everything is fine," Kuijs warns.

"Clearly, when food prices are increasing by about 18 percent year-on-year as they do in China at the moment, that hurts people's purchasing power. It means, other things being equal, they have less money available to buy other things. This affects especially the poor people who spend a larger proportion of their money on food."

According to Kuijs, if on average, a Chinese person spends one-third of his income on food, a poor urban person could see this figure rise to as much as one-half of his income.

Louis Kuijs is the main author of the World Bank's China Quarterly Update (Image: L. Kuijs)And while most would welcome an increase in wages, Kuijs says that salary hikes could in effect strike a blow against China's competitiveness. "The longer that these food price increases persist, the higher the risk becomes that people demand wage increases to offset this hit on their purchasing power. So businesses might have to pay higher wages that may put pressure on costs. That would by itself weaken China's competitiveness position vis-a-vis other parts of the world."

Communication is key

A tight monetary policy and price control are some of the measures that policymakers are employing to help rein in inflation.

"The government is putting quite a bit of emphasis on having a relatively tight monetary policy. The form that takes, depends on, well, China's monetary policy is not conducted in the same way as it would be in the euro area or in the United States, but there are moves to a tighter monetary policy."

"Chinese leaders have also used a few administrative measures including some price controls to dampen inflationary pressures and to contain expectations on inflation."

Kuijs says that there is a big debate on the pros and cons of price controls. "Most economists believe that price controls could be a reasonable instrument to use in the short run but it might not be a good strategy to use over longer periods of time. Most of us think that price controls cannot be the main element of the fight against inflation but, at the same time, most economists see some justification for using certain types of price controls when other measures cannot be easily implemented."

He observes, though, that the Chinese government intends these price controls to be temporary. "Price control measures may well serve their purpose without doing undo harm to incentives, such as the incentive to produce."

Kuijs mentions a third element in keeping inflation under control: communication. "As long as people believe that food price increases are temporary and as long as they believe that the authorities are doing what is needed to make this temporary, then people will moderate their wage behavior and businesses will moderate their price increases. What's absolutely key is containing these inflationary expectations. Price controls, monetary policy and communication about it are all very important elements in the fight against inflation."

Equality, efficiency and environmental sustainability

Rising food prices are affecting the poor urban people in China most. (Image: Radio86)Apart from inflation, another macroeconomic challenge that faces China is its external surplus. "China has a surplus of foreign exchange that will remain very very large regardless of what happens to the state of the world economy."

"Another issue is this: in a climate of uncertainty about the world economy on the one hand and a very strong domestic economy on the other hand, what should macroeconomic policy do? Should policy continue to to try to tighten because the domestic economy is so strong or will the real economy face hits coming from the world economy? Should that be a reason for monetary policy to be loosened?"

"There are probably three key structural improvements that we, and the government particularly, would like to see. These are China's key economic challenges when we think about the longer term strategy – making growth more environmentally sustainable; making growth more equal between urban and rural and also between different parts of the country; and, lastly, to increase the energy and other resource efficiency of the economy," Kuijs concludes.