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China Quarterly Update, January 2008

Summary
 

Summary: OverviewRecent Developments | Prospects and Policies | Financial and Corporate Sector

Also in this report
Special Focus:
 
New PPPs
and China's Economy
An explanation of how the recently released improved estimates of China's GDP affect our understanding of country economies and of poverty rates. More
 

   
Special Topic:
 
China's Railways
China’s ambitious plans for further expansion of its vast railway network and some of the policy challenges involved.
  More
 

 

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Data
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Slideshow: 
See all data charts from the main report.
 
Discuss the findings
Speak Out

Louis Kuijs, Sr Economist and author of the report, and David Dollar, WB Country Director for China, discussed the report during a live online chat. 

Read the transcript
 
China Development Blog
 
Related conversations:
New PPP figures show deeper poverty reduction in China
 Is China de-linking from the U.S. economy?
 
News release
 
 
   

OVERVIEW

  • China’s economic growth has begun to inch down from its record rates earlier in 2007, while food prices are lifting inflation.
     
  • The global outlook has weakened and is uncertain, but China is likely to grow robustly and is well-positioned to stimulate demand if needed.
     
  • Macroeconomic policy needs to address the challenges of inflation and persistent external surpluses.
     
  • The government recently introduced further administrative measures to contain inflation.
     
  • The recent revision of purchasing power parity (PPP) estimates does not change the conclusions about China’s growth and poverty reduction.

 

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RECENT ECONOMIC DEVELOPMENTS

  • Economic growth remained strong in 2007, but the economy appears to have slowed down somewhat in the second half.
     
  • The slowdown in demand was due to a declining contribution of external trade to GDP growth, partly offset by a rising contribution of domestic demand.
  • It is too early to tell whether more general rebalancing of the pattern of growth is taking place.
     
  • More detailed trade data reveals a strengthening of demand for imports in China’s domestic economy throughout 2007.
     
  • Inflation rose considerably, due to higher food prices.
     
  • Some wage cost pressure seems to have emerged, but there is no significant spill over into general inflation yet.
     
  • There are so far few signs of overall excess demand pressure, but there are risks.
     
  • These price and cost developments take place against a backdrop of large balance of payment surpluses that continues to boost liquidity.
     
  • So far, balance of payment surpluses (and the policy response to them) have mainly contributed to high asset prices—shares in particular—as opposed to goods inflation.

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ECONOMIC PROSPECTS AND POLICIES

Economic Prospects

  • Global growth prospects for 2008 have deteriorated considerably amidst financial market turmoil and increased uncertainty.
     
  • The expected weakening of global growth is bound to affect China’s economy.
     
  • China’s domestic economy should maintain robust momentum.
     
  • Consumption should grow robustly.
     
  • In light of these considerations, we now project GDP growth of 9.6 percent for 2008.
     
  • The trade and current account surpluses are likely to remain broadly at the high levels of 2007.
      
  • Price pressures should ease in 2008, but inflation is not likely to decline to low levels.
     
  • Risks on price pressures may be on the upside.

Macroeconomic Policies

In light of these developments and prospects, the three key macroeconomic issues that policy makers have to deal with are:

  1. The likely impact on China of the prospective global slowdown: China is well-placed to deal with a contained global slowdown, but in the case of a more pronounced global slowdown and impact on its economy, China is in a strong macroeconomic position to stimulate demand.
     
  2. Inflation: So far there is limited spill over of higher food prices into more generalized inflation and no obvious overall excess demand yet. Economic policy makers need to ensure this remains the case and that inflation expectations remain contained. This calls for relatively tight monetary policy  (details below) and effective communication, while exchange rate policy also matters. The government has also implemented administrative measures (details below) including some price controls, and it could consider using direct subsidies.
     
  3. The continued large balance of payment surpluses that inject liquidity into the economy.

Inflation concerns and balance of payment surpluses have implications for monetary and
exchange rate policy, and administrative and fiscal measures:

Monetary and exchange rate policy:

  • With monetary policy remaining constrained by the exchange rate policy,
    administrative measures continue to play a role in monetary policy.
     
  • Looking ahead, monetary policy may continue to rely on credit controls and liquidity
    management.
     
  • The authorities have speeded up the pace of appreciation against the dollar.

Administrative and fiscal measures:

The government has introduced several administrative and fiscal measures to dampen price rises, keep items affordable, and manage expectations.

As the government may consider additional measures, there are several observations to make. How do these general considerations help in deciding what to do if food price pressures intensify?

  • Under current circumstances, price controls have short term benefits and costs.
     
  • In the longer run, the detrimental incentive effects are likely to outweigh the benefits.
     
  • Thus, administrative measures such as price controls and quotas should be used sparingly and should not be relied on for long periods of time.
     
  • Short-term considerations should not distract from the strategic direction of reform.
     
  • Given the government’s strong fiscal position, the authorities could consider introducing direct subsidies.
     
  • To minimize costs and keep subsidies justifiable, direct subsidies are, if practically possible, best targeted at the most needy groups.
     
  • The use of administrative and fiscal measures should be flanked by consistent
    macroeconomic policies.

Other fiscal and structural policies—key for rebalancing

During the last six months, many fiscal and structural policy initiatives have been taken. Other highlights include:

  • State-owned enterprises will pay dividend to Government from 2008.
     
  • Some progress has been made in reducing the energy intensity and emission.
     
  • The government cracks down on environmental violators.

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FINANCIAL AND CORPORATE SECTOR POLICIES AND DEVELOPMENTS

Capital market developments

  • China’s stock market saw another year of fast growth in 2007.
     
  • Major reforms in the law enforcement in the equity market were implemented.
     
  • Capital markets opened up further to foreign participation.
     
  • The first corporate bonds were launched under new, simplified rules.

SME Finance

  • Several efforts have been made to improve access to finance by SMEs through the capital markets in 2007.
     
  • Discussion is going on about a new board for high growth enterprises.

Housing Finance

  • China’s government has stepped up its efforts to meet the demand for affordable housing from lower and middle income households in cities.
     
  • There are several obstacles to develop appropriate products for this group of borrowers:
     
    1.A lack of effective credit information system for the lenders to track the credit history of borrowers.
     
    2. The property registration system in China is not a national system, making it difficult for lenders to verify the housing status of the borrowers.
     
    3. There are no effective mortgage insurers in the market to share the risks with mortgage lenders to reduce the down payment and provide the necessary insurance coverage for defaults, which will help the lower and middle income households to buy their houses earlier.

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