Sunday, November 30, 2008

Article: Faced with global slump, can China keep up economic growth?

Thursday, October 23, 2008

BEIJING: For three decades, China has fueled its remarkable economic rise by becoming the world's workshop and unleashing a flood of low-priced exports. But faced with a possible global recession and weakening demand for Chinese exports, the question now is whether the ruling Communist Party can prevent the financial crisis from derailing the country's economic miracle.

This is a pressing question not just for China but for the rest of the world. Many economists say continued Chinese growth is vital to the global economy as the United States and Europe face severe downturns.

Yet to navigate the crisis, many analysts say China will need to recalibrate its economic model, stoke domestic investment with heavy government spending and promote policies to increase consumer spending in a nation famous for high savings rates.

The global financial crisis is expected to be the main focus of a summit meeting of Asian and European leaders in Beijing this week.

It is also arising at a politically resonant moment for China. This is the 30th anniversary of the policy changes that propelled China's economic rise, a milestone that has raised inevitable questions about the future shape of reform. At the geopolitical level, China would seem well positioned to expand its influence as it sits on $1.9 trillion in foreign exchange reserves and could benefit from widespread calls to reorganize Western-dominated global financial systems.

But for now, most analysts say China's top priority is simply protecting its own economy. Chinese leaders say the domestic financial system is largely insulated from the global crisis but also warn of serious pressures at home and from abroad. Economic growth is at the lowest level in five years, unemployment is a growing concern and scores of factories are closing in the country's export region. Domestic stock exchanges have lost 65 percent of their value and real estate sales have plummeted.

Many economists believe China can avoid a serious downturn, but a significant slowdown would pose a political challenge for the Communist Party, which derives much of its legitimacy from delivering economic growth. Conventional wisdom holds that China's output must grow at a minimum of 8 percent for the economy to produce enough jobs to meet demand, and many economists expect growth to drop below that level next year.

Just last week, thousands of unemployed workers protested outside closed toy factories in Guangdong Province, the country's export hub. Slightly more than half the country's toy exporters shut down in the first seven months of this year, mostly very small companies that struggled to cope with new safety standards as well as weakening Western demand, according to China's customs agency.

If the growth rate "goes below 8 percent in 2009, I think they will be quite concerned," said Kenneth Lieberthal, a China specialist at the Brookings Institution in Washington. "They are always concerned about job creation."

Already, Chinese leaders are preparing a response that could resemble the government spending spree from 1998 to 2000 that is credited with helping China avoid the worst of the Asian financial crisis. Former Prime Minister Zhu Rongji poured billions of dollars into projects like flood control, road building and new airports to pump economic output. Much of that infrastructure is now considered essential to China's competitive advantage as a manufacturing exporter.

Today, improvements are needed in railroads and the electrical power grid. But China's most conspicuous needs are the softer side of a modern economy — a health care network, lower tuition and fees for schools and universities and improvement in the rudimentary social safety net, economists say.

Such steps are seen as crucial if China is to give consumers — especially working-class urban residents and the 800 million people still classified as peasants — the confidence to spend rather than increase their savings.

"China's infrastructure is excellent - compare it to India," said Xu Xiaonian, an economics professor at the China Europe International Business School in Shanghai. "It's getting harder for the government to find ways to spend money productively. It's stimulus for the sake of stimulus."

David McCormick, the U.S. under secretary of the Treasury for international affairs, said during a telephone interview that Chinese officials understood that the sheer size of their economy, combined with weakening demand overseas, meant increasing demand for goods and services within China would be in the country's own interest. "They can't count on exports being such a driver of their economy going forward," he said.

To date, the most significant new measure is the land reform announced Sunday after days of mixed signals. Full details of the program are still unclear, but the plan allows farmers for the first time to lease or transfer land, a landmark step in what is still nominally a socialist country. Economists believe the measure will lift the rural economy, though few predict sudden benefits. To raise rural incomes more rapidly, the top Chinese economic planning agency on Monday increased the minimum purchase price of wheat by up to 15 percent beginning next year.

But transforming the countryside and creating a nation of consumers is likely to be a more difficult process than China's transformation into a manufacturing giant. In recent years, President Hu Jintao and Prime Minister Wen Jiabao have eliminated the ancient agricultural tax and increased spending on rural initiatives. Yet the rural-urban income gap has continued to worsen. Today, China still has more than 500 million people living on less than $2 a day; nationwide per capita income is only about $2,000. The social safety net remains so inadequate that most peasants save their spare earnings to protect against a medical crisis or as a thin cushion for old age.

Andy Rothman, a longtime analyst at CLSA Asia-Pacific Markets, an investment bank, said that the government had been promoting domestic consumption for years but that by necessity it was a gradual process and not one that could provide a quick fix to a global slowdown.

"This isn't something you want to move ahead at light speed," Rothman said. "China trying to step into the breach by handing out credit cards to 800 million peasants would be a disaster just a few years down the road."

From a geopolitical standpoint, China would seem to have an opportunity to fill a void created by a weakened West, especially given the country's huge foreign exchange holdings. President Asif Ali Zardari of Pakistan visited Beijing earlier this month in search of financial edge to help his country stave off bankruptcy - an overture that could become more common as China is increasingly perceived as sitting on a money pot.

More pertinent to the United States is whether China will re-examine its strategy of financing U.S. debt. Chinese experts say that the American and Chinese economies are so intertwined that Chinese leaders will not make any abrupt changes in its policy of directing the bulk of its foreign currency reserves to dollar-denominated assets. Indeed, the U.S. Treasury secretary, Henry Paulson Jr., and other senior U.S. officials have been in almost daily contact with their Chinese counterparts.

"China, with the responsibility of a big country, will not make trouble for international financial markets," said Hu Angang, a Chinese economist who is the director of the Center for China Studies at Tsinghua University. "The Chinese government is very rational and flexible, and very clearly recognizes any policy does not just influence domestic markets but also global markets."

McCormick said that U.S. officials had not asked their Chinese counterparts to buy any specific portion of the Treasury bonds that would be issued to finance the Bush administration's $700 billion economic recovery plan. But U.S. officials have tried to impress on Chinese officials that the United States remains an attractive place to invest.

"We've certainly tried to give them confidence we're taking the appropriate policy steps," McCormick said, adding that the United States had also encouraged China to continue to be "a stable and long-term investor in the global financial system."

Some Chinese experts are suggesting that China could use more of its foreign reserves to purchase stocks in Western companies and even leverage positions onto corporate boards. Doing so, these experts say, would allow China to develop expertise and gain more experience in global business.

But others say China was stung by the backlash after a state-owned Chinese petrochemical company sought to purchase Unocal and would be cautious in making any moves deemed politically risky. Domestic pressures also exist; public criticism has erupted after some investments by the country's sovereign wealth fund lost money.

McCormick said that the United States welcomed investments by sovereign wealth funds, whether from China or any other country.

No one is yet certain when the global financial system will stabilize, but the crisis has convinced many economic analysts that the system itself will be re-examined. The financial crisis is "a ground-shaking event, but people are going to stick to the same system," said Wang Tao, chief of the China economic research unit for UBS Securities. "But they are going to think about how to reform the system, and China will probably have a stronger voice than before."

In recent years, some Chinese experts have written analyses about the inevitability of an American decline and how China must prepare to manage it. But in the face of the current crisis, most Chinese analysts say China is nowhere near ready yet to stand as a superpower.

"China doesn't want to be viewed as a replacement for the States," said one Chinese scholar who requested anonymity so that he could discuss the mind-set of government officials. "We are still a developing country. We have more foreign reserves than other countries, but we also have more problems."

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