BEIJING MUST TACKLE ECONOMIC CHALLENGES / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

Beijing must tackle economic challenges

By George Magnus

Published: December 19 2010 18:38

The revelation that China plans to build its first aircraft carrier to boost its maritime power, coupled with other demonstrations of greater political assertiveness, has important implications, including for macroeconomic management. In the coming year, China’s leaders face big decisions as signs of overheating of the economy become apparent, and with increasing pressure to reboot the country’s development model.


But politics in China mean responses to these challenges will be enigmatic and uncertain.


Growing intolerance of domestic opponents, and a prickly posture in the face of perceived foreign ones, are not unique to China, but they have constituted an Achilles heel in its long history. China’s recent shift in attitude could be related to the leadership transition, factional struggles in the Communist party, growing self-confidence or rising social unrest. But these can all be slotted under deep-seated insecurity and intransigence.


Neither is auspicious when China has to deal with rising cyclical and credit inflation, and the call for economic transformation. Both are liable to weaken the resolve to pursue change that will be disruptive in the short term, but harder if deferred.


Chinese economic growth is running at about 9 per cent, with November releases for output, electricity consumption, fixed asset investment, exports and retail sales all surpassing expectations.


The government wants to slow growth a bit, but China’s economy resembles an express train with two speeds: maximum and stop.


Controlling inflation without causing politically sensitive growth to falter is challenging enough. But rising inflation, up to 5.1 per cent in November, would also threaten stability, and Chinese blogs and papers have reported a growing number of inflation-related “incidents”.


Food prices are the popular explanation. But rising inflation is what we expect in an economy where credit conditions are loose, wages are rising more quickly and underlying economic momentum is robust.


House price inflation has slipped to 9 per cent recently but the market remains firm.


The M2 version of the money supply and renminbi-denominated bank credit have risen by 55 per cent and 60 per cent, respectively, since the end of 2008. M2 is still growing at close to 20 per cent a year. Benchmark this by considering that Chinese M2 is 20 per cent bigger than in the US, although the economy is a third of the size. Even if the US data included M2 loans and deposits outside the formal measurement, the oddity of the contrast would hold. Real deposit rates in China are now -2.6 per cent, and real lending rates are barely positive.


After bank reserve requirements were raised six times this year, further increases can be expected, along with some increase in interest rates.


China has already stated it intends to adopt a “prudent” monetary policy, and we shall see what this means in practice.

But given the huge political sensitivity of stable and high growth, and the leadership succession in 2012, the central bank may remain behind the proverbial curve for a while. If inflation continues to rise, though, a sharp response would be inevitable.


Tackling inflation while changing the development model makes economic management all the more important.

Economic rebalancing is about hoisting the share of consumption and services in gross domestic product, as that of capital spending and exports declines. In this way, China’s gross savings, the root of the high trade surplus, should fall from the current elevated level of 53 per cent of GDP. Put another way, it is about the transfer of vested economic and political interests from companies to consumers, cities to countryside, and savers, including the corporate and the government sectors, to spenders. Such a transformation will not be seamless, and because China is modernising rapidly, it may entail political reforms that are deemed incompatible with Communist party rule.


That is why the recent shift in China’s political mood and aspirations is significant in a wider sense. It symbolises a mixture of apprehension, insecurity and perhaps hubris. It reinforces a point, lost in mainstream economic predictions about how important robust and adaptable political, social and legal institutions are to sustained economic success. This is not a good time for China to be getting grizzly, not least from the standpoint of the world economy.


The writer is author of Uprising: Will Emerging Markets Shape or Shake the World Economy? and senior economic adviser at UBS Investment Bank


Copyright The Financial Times Limited 2010.