China's economy sees emerging V-shape recovery

BEIJING, July 6 -- Faced with a severe economic downturn at the end of

last year and the beginning of this year, people are debating intensely the

prospects of the Chinese economy. However, there is increasing evidence to

indicate that the ongoing recovery is likely to be V-shaped.

Factual evidence of a strong rebound can be found in China's steel

output, electricity production, industrial value added, foreign trade as well

as the Shanghai Exchange's A share index which has jumped by 65 percent so

far this year. China's surprising pent-up automobile sales amid the global

recession shows that no matter how radical a prediction about the Chinese

economy is, it still risks being too conservative. The country is now set to

break the mark of selling 10 million new cars in a year. Yet not so long ago

it was still deemed too optimistic to expect that the country's car sales can

reach that figure by 2015.

What explains China's rapid recovery?

One is the country's policy mix of demand stimulus, wherein the overall

demand stimulus policy is effectively supported by pro-active fiscal and

monetary polices. Second, strong fundamental factors like China's development

stage advantage and sound balance sheets and financial strength have also

hastened the recovery.

In July 2008, the Chinese government had already shifted its policy focus

from preventing economic overheating and inflation to maintaining stable

growth and control price growth. Then, 10 stimulus measures were announced in

November 5, 2008.

The policies for resolving can be divided into three major categories.

In the first category fall the pro-active fiscal policies with sweeping

tax cuts and massive investment. On the one hand, China has reduced tax on

housing transaction and purchase of car; introduced tax reform to allow

rebates on VAT for investment goods; and, increased the ratio of tax rebates

for various exports. On the other hand, the country has kick-started a "4-

trillion-yuan ($585 billion) investment plan".

Second, pro-active monetary policies have been adopted to bring down

interest rates from 7.2 percent to 5.31 percent for 1-year loans, and from

3.87 percent to 2.25 percent for 1-year deposits. Required reserve rate was

cut down from 17.5 percent to 14.5 percent while quantitative control on

credit was abolished.

Third, the State Council announced industrial promoting plans for 10

targeted sectors including steel, automobile, textile, equipments, ship-

building, electronics and IT, light industries, oil and chemicals, non-

ferrous metals, and logistics and distribution.

Extra-investments from "the 4-trillion-yuan plan" and huge credit

expansion have definitely played a crucial role in boosting the country's

aggregate demand. It was estimated that the plan would contribute one

percentage point of GDP growth during the period.

Why are the stimulus policies so effective?

The underlying reason is that China is still at the development stage of

rapid urbanization and industrialization. China has a ready demand for

infrastructural construction to support its ongoing urbanization and

industrialization. The sound domestic financial situation also helps a lot.

In short, the Chinese V-shaped recovery is the result of strong

government policies of massive investment and credit expansion. It is

supported by uniquely favorable fundamental factors in terms of developmental

stage combined with the financial soundness of the basic sectors of the

economy.

The case has several implications for Chinese policymakers.

First, the expected strong recovery is likely to confirm that China does

not have to excessively rely on external demand. A growing trade surplus is

not a necessary condition for generating sufficient demand to match the

growth of potential supply. Second, on managing demand, policymakers should

realize that insufficient aggregate demand might cause a lot of problems,

especially if it is the consequence of a balance sheet crisis. But, the

government commands effective policy instruments to boost demand.

Finally, it is the importance of further reform. Deepening reform and

structural change is the long-term priority for achieving China's sustainable

growth. The country needs to press ahead with market-oriented reform in land

system, resource price, and market access for non-SOEs. It should also

establish a holistic management regime consistent with the open macro-economy

through reform of interest rate and exchange rate system. And, social reform

and structural adjustment in areas of social security, health systems, and

environmental protection cannot be delayed any longer.

(Excerpts from a speech delivered at the 11th NBER-CCER conference. The

author is a professor with China Center for Economic Research of Peking

University. )

(Source: China Daily)