• Large fiscal and monetary stimulus has supported a recovery in China’s economy. 
  
• Growth is likely to remain robust in 2010, but the composition will change.
  
• On policies, the costs and risks of sustaining the current expansionary policy stance will increase over time.
  
• In the medium term, the recovery can only be sustained by successful rebalancing of the economy.

• In a difficult global climate, exports  have been a major drag on growth.
  
• Nevertheless, overall growth held up very well through the third quarter, driven by domestic demand.
  
• The domestic demand expansion has been fueled by very large fiscal and monetary stimulus.
  
• While much of the stimulus showed up in infrastructure-oriented government-influenced investment, the domestic demand surge has been more broad based.
  
• Resurgent housing sales have started to feed through to construction activity.
  
• Other market based investment in several sectors, notably manufacturing, has lagged, as excess capacity is limiting the incentive to invest.
  
• Consumption has held up, but lagged investment.
  
• The surge in domestic demand fuelled imports.
  
• The slowdown has had a major impact on the labor market, but the worst may be over.
  
• Underlying inflationary pressures remain largely absent.
  
• The RMB has been kept virtually pegged to the US dollar since mid 2008.
  
• The current account surplus has declined materially, but reserve accumulation has continued.
  
• The stock market has declined since July, after having risen sharply earlier in 2009.

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• Global economic activity seems to be recovering.
  
• However, there are several challenges to overcome, and the global recovery is likely to be slow and subject to risks.
  
• Against this light, global price pressures are expected to remain modest next year.
  
• In this setting, China’s exports should resume growth in 2010, but global demand is likely to remain subdued.
  
• China is on track to meet the government’s target of 8 percent GDP growth this year.
  
• We project growth to increase somewhat in 2010, with a marked shift in the (expenditure) composition.
  
• Consumption may feel some headwind.
  
• Inflation is likely to remain subdued.
  
• China’s external surplus is set to shrink sharply this year, and only rise somewhat in 2010.
  
• Medium term growth prospects are less favorable than recent experience, but rebalancing could buoy sustained growth.

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• The government has expressed its intentions to keep the overall macroeconomic policy stance broadly unchanged for now.
  
• In our view, macroeconomic conditions in the real economy do not yet call for a major overall tightening.

• However, the costs and risks of sustaining the current expansionary policy stance increase over time.
  
  • In the monetary sphere, risks of asset price bubbles and misallocation of resources amidst abundant liquidity need to be addressed.
    
  • Significant additional fiscal stimulus does not seem warranted, although flexibility is.
    
  • In the medium term, the recovery can only be sustained by successful rebalancing of the economy.

Monetary and exchange rate policy 

• Serious asset price bubbles are unlikely to be imminent.
  
• However, risks of misallocation of credit and bad loans are real and it pays to be proactive.
  
• China’s  exposure to asset price risks differs from that of  most other countries.
  
• The authorities have taken several steps recently in an effort to mitigate these risks.

• Eventually, general monetary tightening will be required to dampen these risks.
  
• Several types of financial market policies could enhance financial stability and reduce risks on asset prices and quality.
  
• The government has continued with steps to increase the role of the RMB in international finance and trade (see our June Quarterly Update for earlier steps).

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Fiscal policy

• Remarkably strong revenues in the third quarter limit the increase in the deficit.
  
• In 2010, continued large fiscal stimulus does not seem warranted, although being able to flexibly respond to further shocks is important.

Structural measures and rebalancing 

• The government has recently reconfirmed its commitment to rebalancing.
  
• Some further steps have been taken in recently months to rebalance and boost domestic demand.

Increasing the presence of the government in health, education, and social safety 

• A rural pension program was introduced more widely this year.
  
• An additional rural pension program for currently older farmers was piloted in August.
  
• Progress is being made in implementing the health care reform plan that aims to make health care more accessible and affordable (see our June 2009 Quarterly).
  
• These measures in health are important steps, but more is needed

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Improving access to finance in rural areas and for SMEs and providing other support to SMEs

• The China Banking Regulation Commission (CBRC) is seeking to encourage the establishment of additional financial institutions in rural areas
• Steps have also been taken to improve access to finance for SMEs
• In September 2009, China also launched other measures to support SMEs
• However, some other recent policy initiatives were unfavorable to SMEs

Mitigating resource use and environmental damage

• Some progress has been made in reforming resource pricing

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