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Business Times - 01 Aug 2006
Can Beijing pilot China towards a soft landing?
Measures taken have yet to show results, and effects of a hard landing will hit far and wide
By FRIEDRICH WU
OWING to Chinese leaders' lack of understanding of the volatile economic forces unleashed by
the 'Open Door' policy and their inexperience in managing the inherent contradictions within a
'socialist market economy', China's economic growth in the post-1979 era has been punctuated
by a series of boom-bust cycles.
In the 1980s, two cycles ended with 'hard landings' characterised by sharp economic slowdowns.
This was repeated during the 1991-97 cycle, although in this episode the government eventually
managed to achieve a 'soft landing' with only a moderate slowdown in growth.
Since 2003, however, Chinese leaders have had to grapple with this recurring economic bubble
once again when GDP growth shot through the roof with a 10 per cent surge, fuelled by a sharp
26.7 per cent increase in fixed asset investment (16.9 per cent rise in 2002). Other key economic
indicators exhibiting 'over-heating' were financial-institution loans, money supply (M1), and
industrial production, which all advanced at near or over-20 per cent rates in 2003.
In addition, both the commercial and residential real estate markets began to attract widespread
speculative activities. The Chinese authorities have since responded to these 'over-heating' signs
with the implementation of a plethora of administrative and market-based measures in 2004,
2005 and 2006 in an attempt to cool the surging economy.
Still heated
These include, among others, prohibition of investments in 500 'sub-industries', raising
commercial banks' reserve-requirement ratio to slow down loan growth, increasing banks'
commercial lending rates and mortgage rates, upping minimum downpayment for property
purchases, imposition of capital-gain tax on property transactions, curbing property developers'
'speculative' projects, revaluing the yuan by 2.1 per cent and re-pegging it against a basket of
currencies to allow for a modest and gradual appreciation, and most recently, restricting foreign
buyers' speculative activities in real estate.
At this juncture, the jury is still out on the effectiveness of these administrative and market-based
measures. While expansion in fixed asset investment, financial-institution loans, money supply
(M1), and industrial output had mostly decelerated in 2004 and 2005, they have all picked up
speed again since the beginning of 2006.
For instance, fixed asset investment clocked a surprising leap of nearly 30 per cent in the first half
of 2006, surpassing even the record 26.7 per cent surge in 2003. Likewise, industrial production
bounced back to its strong growth of 17.4 per cent in January-June 2006, beating the already
high pace of 17 per cent in 2003. Meanwhile, financial-institution loans jumped 15 per cent in the
same six-month period, after slowing to an average rise of 13.8 per cent in 2004-05.
The resurfacing of such runaway accelerations, coupled with soaring exports (up 25.3 per cent),
had propelled China's first-half 2006 GDP growth to a dizzy high of 10.9 per cent.
The return of torrid growth has obviously alarmed Chinese leaders, and had prompted Premier
Wen Jiabao to fire a serious warning in mid-July to his senior officials that 'we need to prevent
unhealthy and unstable situations and the imbalances that can occur during fast economic
development to prevent major ups and downs in the economy'.
Before the month ended, Mr Wen again told his cabinet colleagues unequivocally that 'forceful
measures must be taken to help resolve the striking contradictions that exist to prevent rapid
economic growth from becoming overheated'.
Like past episodes of 'over-heating', the danger of scorching growth fanned by excessive
investment is that it will inevitably spawn overcapacity, which will subsequently lead to falling
company profits and mounting bankruptcies, resulting in rising unemployment and nonperforming loans in the banking system. A snowballing of these combined adverse developments
will, in turn, cause the economy to stall with a big jolt.
Would Chinese policymakers have the savvy to engineer an orderly deceleration of the country's
latest investment and lending booms, and save the economy from a 'hard landing'? Nobody can
be sure at this point.
The key question is whether the leaders in Beijing would have the resolve to rein in provincial and
municipal government officials who are enamored with extravagant construction projects that help
drive the investment frenzy.
The central government's rope-tightening act would also pit the People's Bank of China against
powerful state-owned commercial banks which hitherto have provided almost free-flowing credits
for many investment projects of dubious value. While the outcome cannot yet be known, failure to
avert an economic 'hard landing' this round would have widespread ramifications not only within
China but also beyond its borders, as China's economic linkages with the rest of the world have
multiplied and deepened by manifolds since the last 'near hard landing' episode in the 1990s.
A 2004 simulation exercise conducted by IMF economists found that a sharp slowdown of the
Chinese economy would correspond to 'an initial drop of 2.5 percentage points in GDP and
eventually a 4.0 percentage-point decline if multiplier effects are taken into account. The impact
on the rest of Asia (including Japan), after allowing for multiplier effects, is estimated to be a 0.4
percentage-point drop in GDP growth'.
Domestically, such a precipitous fall in growth would surely bring considerable economic hardship
to the Chinese people and consequently stoke sociopolitical tension. In Asia, economies of
China's main investment and trading partners would also have to sustain various degrees of
collateral economic damages. Further from the region, commodity-exporting countries would also
feel the chill as China is now the world's largest consumer of aluminum, copper, iron ore, steel
and zinc.
Argentina, Brazil, Chile and Peru are particularly vulnerable to a 'hard landing' in China, as on the
average their exports to China amount to nearly 10 per cent of their total exports. Australia and
Russia would also take a knock from a sharp contraction of China's import demand as China has
recently emerged to become these two countries' second and third largest export markets
respectively.
In other words, should Beijing's economic mandarins fail to re-balance the Chinese economy, the
world could possibly witness the first 'Made-in-China' regional growth deceleration with rippling
effects hitting even a few countries outside this continent. With so much at stake, outside
observers must join the Chinese people in wishing their leaders good luck in piloting a 'soft
landing' of the economy.
The author is adjunct associate professor at the Institute of Defense & Strategic Studies,
Nanyang Technological University (NTU). He is also senior research associate in the East Asian
Institute at the National University of Singapore. From 2001-05, he served as director of
economics at Singapore's Ministry of Trade & Industry.
Copyright © 2005 Singapore Press Holdings Ltd. All rights reserved.