China is slowing down—what is the right time to boost growth and how should it be done?

China’s economy is slowing down. After years in which growth seemed only to go up, the pace of growth is moderating, affected by the global slowdown and tightening measures introduced since the fall of 2007 to contain inflation. Nonetheless, data for August on investment and exports surprised on the upside and on current projections the economy is on track to slow down to a still robust pace in line with short run potential growth of about 10 % in 2008. This is after 2 years with growth of almost 12 %, significantly higher than potential growth.

Figure: Growth is moderating but broadly in line with potential image001_07.gif




Source: NBS, World Bank estimates.

Given current weak global prospects, we project GDP growth to diminish further to around 9 % in 2009, even as China’s domestic economy is holding up well. This provides some cooling of demand and price pressures that is helpful against a background of still lingering inflation concerns. Headline inflation has receded to below 5 % in August on the back of low food price inflation, but additional inflation pressure from higher energy and raw material prices is in the pipeline, and oil prices are still much higher than a year ago.

In our view, it would make sense to consider and discuss a stimulus package, although it still seems too early to implement a major package now. On current projections for the world economy–that is, with weak growth in the developed world, but still reasonable global growth–current developments in China do in our view not yet warrant a significant change in the macro policy stance.

However, given the large degree of uncertainty about the world economy, it is good to prepare for unexpected negative surprises. In case the government wants to boost growth, we think a fiscal easing is more appropriate than a significant monetary easing. This is on the one hand because of still lingering concerns about inflation, even though inflation prospects look significantly better now than a few months ago, with lower international prices for energy, industrial commodities, and food and, domestically, a few months of declining headline CPI inflation “in the bag”.

More importantly, given the pressing need to rebalance the pattern of growth from being industry-heavy and capital intensive to one that is more service oriented and labor intensive, a fiscal package is more appropriate. Rebalancing China’s Economy can be done without unduly hurting growth, but it requires a package of largely fiscal and structural measures. In current circumstances, a monetary easing would tend to stimulate the economy along traditional–industry heavy, capital intensive–patterns, whereas a well-targeted fiscal package could help steer the economy towards the kind of rebalanced growth that the government is trying to achieve.


3 Responses to "China is slowing down—what is the right time to boost growth and how should it be done?"

  1. China Bull   September 14, 2008 at 9:26 pm

    Are we too complacent abt the downside growth risks for China? While one can be dismissive about the stock market, the housing market seems to be giving way and this could materially hurt the Chinese consumers appetite to spend. Would be interested in your thoughts on the potential risks from housing downturn…

  2. Mandarin   September 15, 2008 at 6:55 am

    There’s a built-in bias toward capital-intensive investment: they soak up the largest amount of the country’s surpluses, address the real need for new infrastructure, and do nothing to disturb existing socio-political arrangements.It might be a great deal easier to promote services and small business by loosening restrictions to entry, targeted business tax cuts, and placing more purchasing power in the hands of consumers and farmers.Put simply, the country’s surpluses can be diverted outside the central budget altogether. However, this implies a marked change in social arrangements. Higher and enforced minimum wages; mandated shorter hours; opening up the market for imported goods, and having the yuan sharply revalued, would achieve systemic reform quite effectively but they would require a drastic change in the export-lead model of which the leadership is so enamored.

  3. Louis Kuijs
    Louis Kuijs   September 15, 2008 at 9:34 am

    China Bull,I agree, in times like these, it is better not to be complacent about anything. China is sufficiently linked up to the global economy–at least its real economy–for risks to the global economy to translate into risks for China. In general, the domestic economy looks quite strong and provides a cushion. However, as you note, the housing market has shown signs of weakness recently, with developers feeling the pressure of the monetary tightening and housholds reluctant to buy as uncertainty on the outlook has increased. In my view, the main implication of further housing market weakness would be slowing construction activity. This would basically add to the external weakness as risks to overall growth. So far, prices are actually not falling, except in some particular cities. I am not sure that the impact via household balance sheets and/or houshold consumption would be very large. But, yes, the housing sector has emerged as a second source of risks, even as the medium term prospects for the housing market remain healthy.Mandarin,I agree, China’s traditional pattern of growth has a “built in bias toward capital-intensive investment” and an array of structural reforms is needed to shift the pattern of growth. In the paper linked in the blog above we discuss our preferred policy package. It includes several of the measures you mention, including loosening restrictions to entry and a stronger exchange rate. However, fiscal measures take quite a prominent role, because the kind of systemic change needed requires a more ambitious role for the government in health, education and the social safety net, as well as different pricing and taxation policies–to change the relative attractiveness to produce tradables/manufacturing goods compared to nontradables/service goods–and a change in the relationship between SOEs and the state. It also requires changes in the fiscal system to allow migrants to settle down as urban people, which is important for the encouragement of the kind of labor intensive, more service oriented, urban activity that would increase the share of wages in national income in a market-consistent way. Thus, I agree, just fiscal is not enough. However, fiscal measures are likely to help rebalancing, which a monetary loosening would not.