China's Growth to 2030: The Roles of Demographic Change and Financial Reform

This paper is worth a quick glance. What is interesting is the acknowledgement that China's population is not growing so quickly or will even start to contract. I am not convinced that this is true.

China's Growth to 2030: The Roles of Demographic Change and Financial Reform

Rod Tyers
Australian National University (ANU) - School of Economics

Jane Golley
Australian National University (ANU) - Faculty of Economics & Commerce

Review of Development Economics, Vol. 14, Issue 3, pp. 592-610, August 2010

Abstract:
China's economic growth has, hitherto, depended on its relative abundance of production labor and its increasingly secure investment environment. Within the next decade, however, China's labor force will begin to contract. This will set its economy apart from other developing Asian countries where relative labor abundance will increase, as will relative capital returns. Unless there is a substantial change in population policy, the retention of China's large share of global FDI will require further improvements in its investment environment. These linkages are explored using a global economic model that incorporates full demographic behavior. Financial reform is measured by the effect of declining intermediation costs on the wedge between home and foreign borrowing rates, or the “investment premium.” The influence of this wedge on China's projected economic growth performance is investigated under alternative assumptions about fertility decline and labor force growth. China's share of global investment is found to depend sensitively on both its demography and its interest premium, though the results suggest that a feasible continuation of financial reforms will be sufficient to compensate for a slowdown and decline in its labor force.

.

China's march continues - Independent

It is always useful to keep on eye on what the popular press are saying about China's economics recovery. How real this recovery really is is still open to question and is something I will cover in this blog.

The article tells us nothing new. Of course the possible US-China trade war gets a good airing as does "unemployment", "inflation" and "housing bubbles".

China's economy marches on [Independent]

The centre of gravity of economic power is tilting rapidly to the east once again. While the rest of the world struggles to emerge from the deepest downturn in three-quarters of a century, China has returned emphatically to double-digit growth, having hardly missed beat.

The country's economy now stands 11.9 per cent higher than it did at this time last year. Most of the western economies, including Britain, will grow by only 1 or 2 per cent in 2011. China has benefited from the largest proportionate fiscal and monetary stimulus in the world, and a pick-up in exports from the revival in global trade and a competitive currency.

Because of the weakness a year ago, the annual rate looks especially strong. On a quarter-on-quarter basis the pace of growth is slowing slightly, at 2.5 per cent now.

The latest figures also mean that China is almost certain to overtake Japan as the world's second-largest economy, behind the US, in the autumn. Growth in China bottomed out at an annual rate of just over 6 per cent in the first three months of 2009, rising to 10.7 per cent in the year to the last quarter.

"We have got off to a good start this year," said an official spokesman, with typical understatement.

But although stock markets were cheered by the news, confirmation of China's robust recovery comes at a time of renewed tensions between Washington and Beijing about the Chinese currency – the yuan – which many in the US say has been kept deliberately low against the dollar to keep Chinese exports cheap and to protect her trade surplus with America. Some fear that a trade war may break out between the two economic giants.

The European Central Bank yesterday criticised China's huge trade surpluses with the West, saying: "At the current juncture, global imbalances continue to pose a key risk to global macro-economic and financial stability. The stakes are high to prevent a disorderly adjustment in the future that would be costly to all economies."

A meeting to discuss the currency issue between President Barack Obama and the Chinese Premier, Hu Jintao, on the margins of the nuclear summit in Washington earlier this week failed to generate much harmony. Mr Obama urged China to put the yuan on a more "market oriented" footing, but Mr Hu said the currency's value would be set primarily for domestic purposes.

Many economists see an upwards revaluation of the yuan as inevitable, but the timing and extent is a hugely sensitive issue for both nations. In the US, the Treasury Secretary, Timothy Geithner, delayed the publication of an official report labelling China a "currency manipulator" until after the talks between Mr Obama and Mr Hu.

Trade sanctions on China have been advocated by many members of Congress, as well as leading economists such as Paul Krugman. Such developments are of concern far beyond the US and China. A return to breakneck growth rates in China is bidding up world commodity prices. Oil is back to about $86 a barrel, with copper close to $8,000 per tonne and its 2008 price peaks. Higher raw materials prices are choking growth in the West and reducing living standards – one of the ways that income and wealth is being transferred progressively eastwards. America's trade gap with China was one of the main "global imbalances", the fundamental economic forces that led to the credit crunch and what the International Monetary Fund (IMF) now calls "The Great Recession".

Despite frequent pledges by the G20 group of large and fast-growing economies to act on these issues, little progress seems to have been made on the largest problem, the US-China deficit. As a result, China continues to add to her foreign currency reserves, which at $2.4 trillion are the largest in the world (although she did run a freakish trade deficit in February).

Just as the Chinese rely on the US and Europe to provide ready export markets, so too do the western nations depend on the Chinese to buy their government bonds. Any hint by the Chinese authorities that they are about to unwind their dollar reserves usually sends shockwaves through the market for US Treasury securities and the greenback itself.

However, economists are hopeful that the very strength of China's recovery may force authorities there to cool an economy that shows signs of overheating, and to allow the yuan to drift higher, making Chinese goods more expensive and taking the pressure off the US trade deficit.

Prices in China's shops are rising at a remarkably low rate of 2.4 per cent per year but "factory gate" inflation, which shows any price increases in the pipeline, is accelerating.

Meanwhile, the Communist government is openly concerned about house price bubbles developing in many of the nation's big cities. Prices were up 12 per cent last month alone and banks have been ordered to curb their lending. Any rise in interest rates might also push the yuan higher, if the Chinese central bank allowed it.

The current growth rate is running some way ahead of Beijing's official target of 8 per cent this year. This is the pace consistent with creating sufficient jobs to prevent unemployment rising. Such is the size of the Chinese population that 27 million jobs need to be generated every year, about the same as the entire British workforce.

.

More on China's excess capacity problem

Articles on China's capacity problem seem to come in waves. In a follow up to yesterday's post we see that the FT has jumped on the problem.

It is about time that the mainstream press woke up to the illusion that China has created through its massive stimulus package. There has to be payback and it may be coming sooner than we think.

This excess capacity will lead to pricing pressures in the US and Europe - touched on my Tyler in a previous blog post - leading to more firm closures in the West becuase you can bet that the Chinese government will and can afford to subsidise their companies longer that in Europe and the US (even if we were allowed to).

The cost of China’s excess capacity [FT]

The world has changed; but China has not. China has responded to the world financial crisis with what seems to be great success. But this is an illusion. China’s solution – a surge in spending on investment – will create greater excess capacity. China’s high-savings, high-investment economy is costly for its people and destabilising for the world. The time for a radical reform is long past.

In a disturbing new report, the European Chamber of Commerce in China lays out the challenge in six sectors: aluminium, where the capacity utilisation rate is forecast to be 67 per cent in 2009; wind power, on 70 per cent; steel, on 72 per cent; cement, on 78 per cent; chemicals, on 80 per cent; and refining, on 85 per cent. Yet vast additional capacity is on the way.

The scale of the excess capacity is breathtaking. At the end of 2008, China’s steel capacity was 660m tons against demand of 470m tons. This difference is much the same as the European Union’s total output. Yet, notes the report, “there are currently 58m tonnes of new capacity under construction in China”. To the extent that gross domestic product is driven by such absurd spending is a measure of waste, not of economic welfare.

Foreign producers fear the impact of China’s growing surplus capacity on their markets. But this is not just a problem for specific industries. It is a broader problem. China has become hooked on an unbalanced pattern of economic development, in which investment cures this year’s excess capacity by increasing next year’s.

In China’s current development model, household income is taxed, to support corporate profits. Corporations now generate more than half of China’s huge savings. Since consumption tends to grow more slowly than GDP, excess capacity can only be used up via yet more investment or exports. This year, economic crisis has made the latter impossible. But China desperately needs to expand its exports once again. The result may well be a crisis in the trading system.

China’s trading partners have to engage with the rising giant. They must explain that they cannot – and will not – absorb the surplus capacity its heavily distorted model of development is creating. But they can point out that this pattern also damages the standards of living of ordinary Chinese. China has to shift income from its corporations to its households and spending from investment to consumption. What is needed for that is a massive structural reform. This must start now. Indeed, it may already be too late.

.

New York Times on future trouble in big China

Following on from the great petrol mystery comes the great China mystery in aggregate as reported by the New York Times.

Tyler is right to point out the high stakes that the Chinese government is now playing. It cannot afford to fail - the dollar peg aimed at boosting exports and hence growth has worked but the global recession is causing problems.

He is also right to point out the perverse incentives of regional officials. There is widespread "making up of numbers" from what I can gather.

This article is impressively doom-laden but it is about time that these issues were addressed elsewhere. Followers of this blog will know that I have been banging on about these topics for a while.

Civil unrest in China is a distinct possibility is the economy slips up to painfully.

Dangers of an Overheated China [New York Times]

PRESIDENT OBAMA’S recent trip to China reflects a symbiotic relationship at the heart of the global economy: China uses American spending power to enlarge its private sector, while America uses Chinese lending power to expand its public sector. Yet this arrangement may unravel in a dangerous way, and if it does, the most likely culprit will be Chinese economic overcapacity.

Several hundred million Chinese peasants have moved from the countryside to the cities over the last 30 years, in one of the largest, most rapid migrations in history.

To help make this work, the Chinese government has subsidized its exporters by pegging the renminbi at an unnaturally low rate to the dollar. This has supported relatively high-paying export jobs; additional subsidies have included direct credit allocation and preferential treatment for coastal enterprises.

These aren’t the recommended policies you would find in a basic economics text, but it’s hard to argue with success. Most important, it has given many more Chinese a stake in the future of their society.

Those same subsidies, however, have spurred excess capacity and created a dangerous political dynamic in which these investments have to be propped up at all cost.

China has been building factories and production capacity in virtually every sector of its economy, but it’s not clear that the latest round of investments will be profitable anytime soon. Automobiles, steel, semiconductors, cement, aluminum and real estate all show signs of too much capacity. In Shanghai, the central business district appears to have high vacancy rates, yet building continues.

Chinese planners now talk of the need to restrict investment in sectors that are overflowing with unsold products. The global market is no longer strong, and domestic demand was never enough in the first place.

Regional officials have an incentive to prop up local enterprises and production statistics, even if that means supporting projects or accounting practices that are not sustainable. For an individual business, the standard way to get more capital resources is to put forward a plan for growth. Because few sectors are mature, and growth has been so widespread, everyone can promise to be profitable in the future.

Over all, there is a lack of transparency. China’s statistics on its gross domestic product are based more on recorded production activity than on what is actually sold. Chinese fiscal and credit policies are geared toward jobs and political stability, and thus the authorities shy away from revealing which projects are most troubled or should be canceled.

Put all of this together and there is a very real possibility of trouble.

China has had a 30-year run of stellar economic growth. But it’s only human nature for such expansion to breed too much optimism, overextending an entire economy. Americans have found this out the hard way in their own financial crisis.

History has shown that no major economy has grown into maturity without bubbles, crises and possibly even civil strife or civil wars along the way. Is China exempt from this broader pattern?

The notions of excess capacity and malinvestment were common in business-cycle theory of the 19th and early 20th centuries, when growing Western economies had frequent crashes of this kind. Numerous writers, from the Rev. Thomas Malthus to the Austrian economist Friedrich A. von Hayek, warned about the overextension of unprofitable capital deployments and the pain from the inevitable crashes. These writers may well end up being a guide for understanding China today.

What will the consequences be for the United States if and when the Chinese economic miracle encounters a major stumble? A lot of Chinese business ventures will stop being profitable, and layoffs and unrest will most likely rise. The Chinese government may crack down further on dissent. The Chinese public may wonder whether its future lies with capitalism after all, and foreign investors in China will become more nervous.

In economic terms, the prices of Chinese exports will probably fall, as overextended businesses compete to justify their capital investments and recoup their losses. American businesses will find it harder to compete with Chinese companies, and there will be deflationary pressures in both countries. And even if the Chinese are selling more at lower prices, they may be taking in less money over all, so they may have less to lend to the United States government.

In any case, China may end up using more of its reserve funds to address domestic problems or placate domestic interest groups. The United States will face higher borrowing costs, and its fiscal position may very quickly become unsustainable.

That’s not so much a prediction as a very possible contingency, and we should be prepared for it. For now, we should avoid two big mistakes. The first would be to assume that just because borrowing costs are now low, we can postpone fiscal responsibility and keep running up the tab — with the aid of Chinese lending, of course. The history of financial crises shows that turning points can come swiftly and without much warning.

The second mistake would be to demand too many concessions from the Chinese. What we see in the numbers today are a growing China and a somewhat ailing America. Yet there’s a real chance that, soon enough, Chinese economic weakness will be a bigger problem than was Chinese economic strength.

.

China GDP per capita

China is a remarkable and fast growing country. However, GDP per capita is still low relative to the OECD and many other newly developed countries. The population size is the obvious cause.

This will have continued and profound implications not least regarding the real speed by which China will be able to grow as any capital investment needs to be costed against low wages.

From the inbox:

What is the GDP Per Capita for Every Country?

Click on the drop down menu in the right hand corner to see the groups that China belongs to. Current GCP per capita is $6000.

.

Where Chinaeconomicsblog leads the FT is sure to follow

Of course the fact that the FT is covering the "GDP numbers riddle" has nothing to do with Chinaeconomicsblog's coverage but it is good to see the FT picking it up nonetheless.

China’s growth figures fail to add up [FT]

All but seven of the regions reported GDP growth rates above the bureau’s first-half figure of 7.1 per cent. At the start of the year, Beijing set 8 per cent as China’s growth target for the year.

Hmmmm.

However, this is the first time I have seen poetry as the first line of defence.

The criticism has prompted the NBS to launch a campaign last week, entitled “Statistical Feelings: We have walked together – Celebrating the 60th anniversary of the founding of New China,” to boost confidence among statisticians.

The campaign has already produced works such as: “I’m proud to be a brick in the statistical building of the republic.” In another poem, a contributor writes: “I can rearrange the stars in the sky because I have statistics.”

.

"Chinese riddles" - Chinese numbers questioned yet again

This time Radio Free Asia take a sceptical view of China's recent GDP numbers.

This scepticism is more than justified. Does the old adage from school "you are only cheating yourself" apply to the most populated country on earth?

Let us imagine that the numbers are wrong. What harm can it do? It might artificially inflate confidence that may in turn cause a virtuous circle of growth and prosperity? Can it be that easy or is it simply storing up a whole lot of trouble for later?

I have posted this article in full as it makes for important reading. This is an issue I have posted about on this blog on numerous occasions.

The "oil use" issue is important as these numbers are harder to fake. Can oil use fall and output rise by so much? previous correlations suggest not.

Can 100,000 statisticans be wrong? This number of statisticans might even help the UK get its numbers right.

China's Numbers Questioned [Radio Free Asia]

BOSTON—China’s economic growth has won praise in the midst of worldwide recession, but controversy continues to swirl around the accuracy of the government’s claims.

In the run-up to last week’s meetings of the U.S.-China Strategic and Economic Dialogue in Washington, China’s National Bureau of Statistics (NBS) released data showing a strong recovery in the second quarter.

“China is leading the world economic recovery based on fresh data from the first half of the year,” the official Xinhua news agency said, citing an interview with C. Fred Bergsten, director of the Petersen Institute for International Economics in Washington.

According to NBS data, China’s GDP expanded by a robust 7.9 percent in the second quarter from a year earlier, boosting growth to 7.1 percent in the first half of 2009.

But the figures have raised doubts on several counts, most notably because the NBS also reported that China’s first-half exports plunged 21.8 percent.

In an economy driven by exports for the last decade, such a steep decline might have been expected to come as a blow to GDP.

Economists have also questioned NBS reports that industrial output rose 7 percent in the first half, while power generation dropped 1.7 percent.

Oil figures

The government doesn’t report oil demand, but Platts Commodity News estimates that it fell less than 1 percent during the period, while Chinese customs data show crude imports up less than 1 percent.

In May, the Paris-based International Energy Agency noted the lag in oil use and challenged the GDP growth data for the first quarter, calling it “another Chinese riddle.”

The NBS dismissed that criticism as “groundless” in a comment on its Web site.

The latest GDP figures have also been met with deep skepticism from some economists, prompting the NBS to take on its critics in similarly strong terms.

In a Web posting on July 16, Derek Scissors, an economist and research fellow at the conservative Heritage Foundation in Washington, blasted the accuracy of the NBS reports.

“It is reasonable to simply dismiss Chinese economic results,” Scissors wrote.

“Despite starkly limited resources and a dynamic, complex economy, the State Statistical Bureau again needed only 15 days to survey the economic progress of 1.3 billion people.”

“Revisions are a farce: No growth figure has ever been revised down, and announcements of upward revisions are incomplete to the point of uselessness,” he said.

“At best, earlier activity is measured. At worst, results are manufactured to suit the Communist Party.”

Thousands of statisticians

The NBS responded in a lengthy interview with an unnamed official on the English-language China Daily Web site, disputing some of Scissors’ conclusions as “wrong.”

The NBS employs “more than 100,000 statisticians” to compile reports quickly, the official said, adding that “we did not see any sense or kindness in Mr. Scissors’ article.”

In an interview, Scissors said that China’s economy clearly strengthened somewhat in the second quarter, but he argued that the NBS growth data is “internally inconsistent” and “can’t be accurate.”

Scissors rejects NBS arguments that China’s gains in energy efficiency can account for such strong GDP growth when power use has declined.

“The spread between the drop in power consumption and the size of production and GDP growth is too big,” he said.

Other explanations of the data have proved difficult, because the NBS has also reported an 8.7 percent rise in coal production, despite the dip in power generated from coal.

The contradictions may reflect adjustments to inaccurate reporting in the past, Scissors said.

“Their data going back 10 or 15 years is flawed, so you can’t really trust what they’re saying at any particular time because they’re building on a bad base,” he said, citing a similar conflict between falling exports and rising GDP.

“Something doesn’t fit here. What exactly it is, it’s hard to determine.”

Energy experts told RFA they hadn't seen previous cases of such strong economic growth without corresponding power demand.

“It would be very unusual to have rather substantial growth in GDP coupled with a substantial decline in electric power consumption,” said Robert Ebel, senior adviser to the energy and national security program at the Center for Strategic and International Studies in Washington.

“They’re trusting people not to raise questions.”

Large disparities

Mikkal Herberg, research director for energy security at the Seattle-based National Bureau of Asian Research, said that such large disparities cannot be explained by exaggerated energy efficiency gains.

“These kinds of improvements in efficiency in a matter of six or 12 months—that’s just not consistent with energy- intensive industries and the slow turnover of capital stock,” said Herberg, who believes the reporting has grown more unreliable with changes in China’s economy.

“The quality of the information becomes very poor when things are very fluid and changing very quickly,” he said.

The analysts all urge caution in relying on NBS statistics in deciding U.S. policy issues, such as negotiating a new climate change treaty or forecasting an end to the global recession.

“I would hope that our embassy in Beijing is doing what they can to provide people in the government with what they believe is the correct assessment of what’s going on,” Ebel said.

Scissors also responded to the NBS charge that his criticisms were not offered in the spirit of “kindness.”

“Economists all over the world love transparency. It’s what we call truth,” he said, adding that his concern is for better economic policy.

“I want China’s economy to thrive and benefit the world economy, so in that sense, there’s plenty of kindness.”

“There’s not a lot of kindness directed toward the National Bureau of Statistics because I’m very frustrated with them and, of course, so are many other people who follow Chinese data,” Scissors said.

New law

Although the NBS has objected to criticism, the government recently enacted a revised statistics law to toughen penalties for falsifying data.

On July 23, Xinhua also reported that China would take part in a U.S. $4 million (27.3 million yuan) U.N. program to help Asian countries improve statistical reporting.

In Washington, the Strategic and Economic Dialogue meetings concluded July 28 with accords for cooperation on environmental and economic issues but without major breakthroughs in either area.

.

China's growth sneaks over the 6% level

At last confirmation that China's growth is lower than many expected. The 8% figure was never realistic. Why it takes so long for analysts to catch on to what is happening on the ground never ceases to amaze me.

So has China bottomed out? Whilst the FT might think so I believe the answer is no. The figures on energy use and profits tell the story. First, profits fall THEN firms start failing and firing. We are not even at the real firing stage yet. Firms try and struggle on and some will survive but many more must collapse first.

Whilst the pace of decline might slow, it is still a decline. More worrying, whilst bank loans have gone up a lot of these will be very BAD LOANS. This will just make things worse in the long term.



Beijing struggles to prop up growth [FT]

China’s economy grew at an annual rate of 6.1 per cent in the first quarter – its slowest pace since quarterly gross domestic product data was first published in 1992 – as Beijing struggled to prop up activity in the face of the global crisis.

The increase was down from 10.6 per cent growth in the same period a year earlier and 9 per cent for the whole of 2008 but aggressive government stimulus measures begun in the fourth quarter last year have started to yield signs of recovery.

The figure was “indeed quite an achievement” against the background of the worsening global crisis and recession in many of the developed economies that China relies on to buy its exports, said Li Xiaochao, spokesman for the National Bureau of Statistics.

Industrial production growth accelerated 8.3 per cent in March and 5.1 per cent in the first quarter from a year earlier, according to Mr Li.

But aggregate profits at large Chinese enterprises fell 37.3 per cent in the first two months from a year earlier and industrial use of electricity – which is usually closely correlated to industrial production – actually fell 8.38 per cent in the first quarter from a year earlier according to the China Electricity Council.

Mr Li said he had no explanation for the discrepancy between falling power consumption and rising industrial production but insisted that both figures were accurate and the issue required “further study”.

Rapid cooling in the Chinese economy has been led by a collapse in exports and private sector investment. This has prompted the government to fast-track infrastructure projects and spending programmes, and order state-run banks to open the credit taps to flood the system with liquidity.

Although there is still little evidence of new private sector investment, the government’s efforts have led to a rebound in investment figures and show signs of stimulating wider demand in the economy.

Sun Mingchun, an economist at Nomura Securities, said economic data released on Thursday “showed that the economy has gained significant momentum since February”.

Fixed asset investment, which accounted for more than 40 per cent of GDP in 2008, showed a marked acceleration in March, rising 28.8 per cent in the first quarter, 4.2 percentage points higher than growth in the same period last year.

The bulk of the increase came from government-supported infrastructure projects.

The decline in Chinese exports decelerated in March, with exports falling 17.1 per cent from a year earlier, compared with a 25.7 per cent decline in February, leading some analysts to predict a stabilisation in trade. Others said further weakness in external demand was the main risk.

.

"Growing Like China"

Another interesting paper although this one costs money to access to. I wonder how much the CEPR make from this unimpressive policy which restricts the flow of research ideas.

"Growing Like China"

CEPR Discussion Paper No. DP7149

ZHENG MICHAEL SONG, School of Economics, Fudan University
Email: zsong@fudan.edu.cn
KJETIL STORESLETTEN, Stockholm University - Institute for International Economic Studies (IIES), University of Oslo - Department of Economics, Centre for Economic Policy Research (CEPR)
Email: KJETIL@IIES.SU.SE
FABRIZIO ZILIBOTTI, Stockholm University - Institute for International Economic Studies (IIES), Centre for Economic Policy Research (CEPR), CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Email: fabrizio.zilibotti@iies.su.se

This paper constructs a growth model that is consistent with salient features of the Chinese growth experience since 1992: high output growth, sustained returns on capital investments, extensive reallocation within the manufacturing sector, falling labor share and accumulation of a large foreign surplus. The theory makes only minimal deviations from a neoclassical growth model. Its building blocks are financial imperfections and reallocation among firms with heterogeneous productivity. Some firms use more productive technologies than others, but low-productivity firms survive because of better access to credit markets. Due to the financial imperfections, high-productivity firms - which are run by entrepreneurs - must be financed out of internal savings. If these savings are sufficiently large, the high-productivity sector outgrows the low-productivity sector, and attracts an increasing employment share. During the transition, low wage growth sustains the return to capital. The downsizing of the financially integrated sector forces a growing share of domestic savings to be invested in foreign assets, generating a foreign surplus. We test some auxiliary implications of the theory and find robust empirical support.

.

Chinese growth falls from "very high" to just "high" but at what cost?

As economists we are paid to be gloomy and this blog on China is no exception as regular readers will know. It is good to see that the Finanical Times has jumped on the bandwagon.

Readers will have been expecting these figures. The only issue from my perspective is how much the Chinese government will spend to maintain growth at above 6%? I suspect it will be a lot. Yesterday's post on "rising unemployment" demonstrates how actively the Chinese government is involved in managing the economy.

What today's FT article highlights, and is something I have been interested in for some time, is the extent to which FDI into China was really just "hot money" looking for high currency returns hidden under the guise of FDI. This would explain why actual FDI is so much lower than "planned FDI" in all the official statistics.

China’s hard landing [FT]

Ouch. It may not be a recession in technical terms, but China’s data dump this week is expected to show a pretty hard landing occurred in the fourth quarter. Private sector economists reckon economic growth decelerated to about 6-7.5 per cent on
a year-on-year basis, or about half 2007’s 13 per cent rate. Compared with the third quarter, on a seasonally adjusted annualised basis, output probably contracted.

The one-time engine of global economic growth has been spluttering as a result of dented global demand for exports and over-zealous tightening policy at home. A hard
landing, like recession, adds new fear to the mix. With shares and real estate worth sharply less, unemployment rising and deflation round the corner, companies and
households are already reluctant spenders; household savings deposits rose by more than 20 per cent in the year to November. Foreign hot money, too, has turned tail as currency appreciation abated. Opacity on foreign exchange reserves makes it ifficult to draw watertight conclusions, but reserve accumulation last month heavily undershot the sum of the trade surplus and foreign direct investment. Further adjusting for estimated valuation and other changes, Stone & McCarthy Research Associates estimate that unexplained residual outflows totalled about $120bn-$140bn in the fourth quarter.

For bulls, this is all part and parcel of being a paid-up member of the global economy: growth and liquidity cycles wax and wane. Last month’s loan numbers were reassuringly robust, showing a 19 per cent year-on-year increase in local currency lending (flattered by a low base) and the upswing should see investment return to form. That looks overly optimistic given other data points. The sharp deceleration in industrial production, which by November was already running at one-third early 2008 levels and likely fell further last month, hardly sets the case for corporate investment. Persistent over-capacity underlines the point. China’s days of double-digit growth are probably over.

.

Will Chinese growth REALLY hit 8%?

This blog has consistently stated that GDP may well come in below the crucial 7.5-8% level and have expressed concern on the impact this would have on the wider political economy.

I would place myself on the more dismal than usual side of the dismal profession that is economics. Perhaps I have been overly doom-laden on the costs of recession on China?

The alternative of course is that these predictions are over estimates or dare I said "made up". It appears to be a coincidence that we are hitting 8% so closely. If there is one thing I have learnt and that is to have grave doubts about Chinese data. I just do not believe these predictions.

China central bank sees GDP up 8% [FT]

SHANGHAI/BEIJING, Jan 6 - China’s economy will probably grow by about 8 per cent this year, the central bank’s research bureau forecast on Tuesday, the latest in a string of relatively optimistic estimates.

Some analysts have predicted a much sharper slowdown for the world’s fourth-largest economy, to as little as 5 per cent, as factory output growth grinds to a halt and exports shrink from their year-earlier levels.

However, government officials and researchers have centred around the view that China can engineer growth of about 8 per cent this year -- the pace officially targeted by Beijing as what it considers necessary to create enough new jobs.

The research bureau of the People’s Bank of China (PBOC) added its voice to that consensus, saying in a report that they expect a relatively modest slowdown from their estimate of 9.3 per cent growth for all of 2008. The economy expanded by 9.9 per cent from a year earlier in the first nine months of 2008.

The researchers also estimated that consumer prices would rise by less than 3 per cent in 2009, after an estimated increase of 6 per cent in 2008.

Writing in the official Shanghai Securities News, the team, led by Zhang Jianhua, head of the PBOC’s research bureau, cautioned that the risks of deflation were on the rise, fuelled in part by weakness in property investment and overseas demand.

”To effectively counter the risk of rapidly accelerating deflation, the key is to fully implement all manner of policies to expand domestic demand and support growth, and to speed up reform of pricing of basic goods,” they wrote, saying that the report represented their own views, not the central bank’s.

Some private investment banks have also said that they do not expect growth to slow as sharply as many others think it will.

Yiping Huang with Citigroup in Hong Kong said in a research note on Monday that the economy would probably grow by about 8.2 per cent in 2009, as industrial output rebounded sharply from the second quarter.

”We believe in the government’s ability to achieve its growth target,” Huang wrote

.

China’s Economic Growth 1978–2025

A new paper published in World Development that looks carefully at China's growth patterns over the last 30 years and into the future.

This was written before the current financial crisis so is probably already out of date but useful as an historical piece.

This line from the abstract made me laugh in light of a previous post which notes that China's growth has already fallen below 10%.

Overall, China’s economic growth is likely to continue at current rates through 2015 before it gradually slows.

Economists are never to be trusted.

China’s Economic Growth 1978–2025: What We Know Today About China’s Economic Growth Tomorrow

Carsten A. Holza,
Princeton University, NJ, USA
Hong Kong University of Science and Technology, Kowloon, Hong Kong

Accepted 24 September 2007.
Available online 29 August 2008.

Summary

This paper examines China’s future growth prospects and the potential drivers of future growth using two approaches. It first asks in how far China’s recent economic development matches standard growth patterns identified in development economics and trade theory. Second, GDP is decomposed into income components, which in turn are explained, for the reform period, by the quantity and quality of labor; future GDP can then be re-composed from future labor data available today. Overall, China’s economic growth is likely to continue at current rates through 2015 before it gradually slows. Such a growth has numerous implications.

Key words: economic growth; growth accounting; growth forecasts; development theories; education; China

.

"Wrong number": On the reliability of Chinese Data

Following on the heals of the last post and thanks to Chinalawblog for the pointer.

As an economist who works with large amounts of Chinese data this issue has arisen many many times without a satisfactory solution. The Economist discusses this issue at length. I tend to use province level data - this raises a set of problems that this article also covers.

An aberrant abacus

AS CHINA'S importance in the global economy increases, investors are paying more attention to its economic numbers. Yet the country's official statistics are notoriously ropy. Some commentators accuse China's government of overstating GDP growth for political reasons, others complain that the official inflation rate is fraudulently low. So which data can you trust?

One reason to be suspicious of GDP figures is that China is always one of the first countries to report them, usually only two weeks after the end of each quarter. Most developed economies take between four and six weeks to produce them.

So which data to trust. From Statistics that Don’t Add Up [China Business Services]

The Economist also provides a guide (developed by Goldman Sachs) to the reliability of official Chinese numbers. It gives a score to different sets of stats, 5 being the most reliable, and 0 the least:

• Foreign Trade: 5
• Money Supply: 5
• Industrial production: 4
• Consumer Prices: 4
• GDP: 3
• Retail Sales: 3
• Fixed Investment: 2
• Employment: 2
• Average Earnings: 1
• Unemployment: 1

On the issue of province versus country level data:

Chinese provinces independently report GDP, and a weighted average of their figures consistently gives higher rates of output and growth than those reported by the central government (see chart). True, local officials have an incentive to inflate growth numbers because promotion depends upon economic performance; however, experience suggests that number crunchers in local government are more accurate than Beijing's. For instance, the figures first published for 2004 showed that the sum of the provincial GDPs was 19% bigger than the reported national figure. Lo and behold, in 2005, after a national economic census picked up more services, the NBS revised its GDP up by 17%; it also lifted the annual growth rate over the previous decade.

Finally, as someone who uses a lot of trade data here is the good news:

Foreign trade is perhaps the most accurate economic indicator. Critics accuse China of fiddling its trade figures, because the value of its exports as measured by the importing country is always much bigger than what the Chinese report. This discrepancy reflects the fact that China's bilateral trade figures exclude goods shipped to Hong Kong before being re-exported. But this should not affect total export figures and detailed Hong Kong data are available to adjust bilateral trade flows.

An interesting topic.

Hot money and the calls for a maxi-revaluation

Brad Sester over at RGE monitor has a neat little article (with good figures) outlining the dangers of holding off the revaluation much longer.

For the record I cannot see it yet. The political implications are too great (the perceived job losses associated with a loss of competitiveness).

A good article and worth reading.

What keeps Zhou Xiaochuan up at night [RGE monitor]

Friday’s Lex column highlighted the possibility that China’s real reserve growth may be far higher than the published increase in its reserves – and thus a lot more hot money may be flowing into China than the published increase in China’s reserves implies. Michael Pettis – drawing on the work of Logan Wright of Stone and McCarthy - and I have both published online estimates of the “true” pace of Chinese reserve growth. Wang Tao – formerly of the Bank of America – and Stephen Green of Standard Chartered have done similar work.

.

China's obsession with cars

In another example of the West attempting to prevent China and India enjoying the trappings of capitalism and growth, China and India and urged to avoid copying the West's obsession with fast and/or large cars.

As with global warming in general the sentiment is correct - if China and India copy our excessive reliance on the motor vehicle then the planet with hasten its own demise.

The interviewee in this article is right to point the finger at the West's media to blame for fueling the dreams and aspirations of the average Indian or Chinese citizen.

China, India Urged To Avoid Obsession With Cars [PlanetArk]

BOAO - China and other big developing countries such as India need to take steps to avoid being over-reliant on private cars, the head of the Nobel Peace Prize-winning UN climate panel said.

Rajendra Pachauri, head of the Intergovernmental Panel on Climate Change (IPCC), told Reuters that investing in improving railways and urban public transportation was one way countries such as China could balance the need for fighting climate change with that for economic growth.

"This excessive and growing reliance on private vehicular transport is certainly something that doesn't suit large, populous countries like China and India," Pachauri said.

"So we have to find a different model for that -- much more efficient and better railway systems, much better local transport in terms of use of public transport options," he told Reuters on the sidelines of the Boao Forum for Asia held in the southern Chinese island province of Hainan.

China is already the world's second-largest vehicle market, despite only a small fraction of urban residents owning a car.

With incomes rising, car sales are growing by more than a fifth each year, contributing further to serious air pollution in cities, as well as to emissions. China is set to surpass the United States as the world's top emitter of carbon dioxide.

For its part, India will this year see the world's cheapest car, the Nano, hit its roads, bringing car ownership closer to within reach for millions of poorer consumers.

DISTANT DREAMS

Pachauri acknowledged that investment in better public transport alone would not be enough to curb growth in private car ownership. Lifestyle changes stemming from better awareness of environmental issues would be important as well, he said.

That, in turn, places responsibility on Western countries.

"You won't get lifestyle changes in the developing world unless the developed world also makes some efforts to bring about those changes," he said.

"I mean, everybody over here watches television and they see all the good things in life in the developed world and naturally they're not prepared to give up that distant vision or dream."

.

Government Efficiency in China

The New York Times looks at China's atempt to improve government efficiency. This is an interesting area of research and there have been other cross-country studies looking at, for example, the effect of government on FDI. Studies have also been written looking specifically at province level efficiency in China.

China Retools Its Government in Efficiency Push [New York Times]

BEIJING — China announced Tuesday that it would reorganize the central government by creating five so-called superministries, including one responsible for improving environmental protection. But the plan stopped short of creating a single agency to oversee the contentious issue of energy policy.

../

The plan, submitted Tuesday during the annual session of the National People’s Congress, the legislature run by the Communist Party, is intended to streamline an overlapping array of government agencies, commissions and ministries around core issues: environmental protection; social services; housing and construction; transportation; and industry and information.

China’s complex bureaucracy is widely regarded as inefficient and often ineffective at carrying out policies that flow from Beijing, in part because agencies become enmeshed in turf battles or are focused on protecting their own entrenched interests.

../

Chinese state media quickly framed the plan, expected to be endorsed this week by the legislature, as a major bureaucratic reform that would improve the way national policies were carried out. But the practical impact is far from certain as China’s bureaucracy struggles to manage soaring energy demand, rampant pollution, rising inflation and an economy that some analysts say is perilously close to overheating.

../

Despite three decades of market reforms, China’s economy is still heavily shaped by the government’s central planning agency, the National Development and Reform Commission. Some analysts had contended that the government could become more efficient by stripping away some of the commission’s responsibilities, including energy policy. Speculation had centered on whether an independent energy ministry would be established.

The new plan divides authority over energy. A new “high level” energy commission would develop national energy strategies. But an energy bureau under the central planning agency would control administration and oversight of the energy sector.

Yang Fuqiang, director of the Beijing office of the nonprofit Energy Foundation, said the creation of the two energy agencies represented a political compromise. He predicted that they would eventually be merged into a full ministry, but not for a few more years. “This is a first step,” Mr. Yang said.

The plan also puts the country’s food and drug regulatory agency under the control of the Ministry of Health. China’s regulatory system has come under heavy international criticism because of scandals involving contaminated or counterfeit ingredients in food and drugs. The Chinese state news media said the new arrangement “would make for better food and drug safety.”

Mr. Kroeber said one significant change in the restructuring plan was that the central planning agency would no longer have final approval on major construction projects. But he said that calling the new entities “superministries” overstated their power and that they seemed to represent a “half step.” He said the expanded ministry over transportation would oversee civil aviation and urban road transportation, but would not include the current Ministry of Railways, which lobbied strenuously to remain autonomous.

“They haven’t gotten all the way to a coordinated transportation ministry,” Mr. Kroeber said.

The new environmental ministry would seem further proof of the emphasis placed on fighting pollution by President Hu Jintao and Prime Minister Wen Jiabao. Environmentalists have complained that the State Environmental Protection Administration was easily steamrolled in bureaucratic turf battles because it did not rank as a full government ministry. The new plan elevates the agency to ministry status, presumably with greater clout inside the bureaucracy.

Yet it is unclear if that new status will also include an expanded budget for a larger staff to carry out regulatory policies. Currently, the agency has only a few hundred employees to coordinate and regulate environmental protection.

../

Xie Zhenhua, a vice chairman of the National Development and Reform Commission, said the country was steadily decreasing its energy use, but still not meeting the target of annual 4 percent reductions.

World Development Special Issue: Asian Drivers

World Development has a recent special issue looking at the impact of Asian drivers on the developing World. The quality of papers in World Development is usually average to good.

Some interesting papers and some "not so interesting" papers. Special issues can often mean a lower average quality of contribution.

The Impact of Asian Drivers on the Developing World

Introduction: The Impact of Asian Drivers on the Developing World
Pages 197-209
Raphael Kaplinsky and Dirk Messner

Asian Growth and Trade Poles: India, China, and East and Southeast Asia
Pages 210-234
Scott McDonald, Sherman Robinson and Karen Thierfelder

The Impact of China on Latin America and the Caribbean
Pages 235-253
Rhys Jenkins, Enrique Dussel Peters and Mauricio Mesquita Moreira

Do the Asian Drivers Undermine Export-oriented Industrialization in SSA
Pages 254-273
Raphael Kaplinsky and Mike Morris

Global Governance and Developing Countries: The Implications of the Rise of China
Pages 274-292
Jing Gu, John Humphrey and Dirk Messner

Do the Asian Drivers Pull their Diplomatic Weight China, India, and the United Nations
Pages 293-307
Andrew F. Cooper and Thomas Fues

China’s Capacities for Mitigating Climate Change
Pages 308-324
Carmen Richerzhagen and Imme Scholz

Breakthrough China’s and India’s Transition from Production to Innovation
Pages 325-344
Tilman Altenburg, Hubert Schmitz and Andreas Stamm

.

Asian interdependence and the US recession

After writing the previous "Has China's growth peaked" I hinted at the interdependence of Asian countries and their subsequent relationship with the US and EU.

When one looks at the raw numbers, e.g. the % of exports to the US it might not appear to be that high. However, when one takes its account the exports of intermediate goods to other Asian countries that are then exported to the US and EU you can see that the problem goes a lot deeper. There are many academic papers that are looking at production networks and fragmentation in Asia and I may even have written one of two of them.

This is the important quote with numbers. Intuitively they appear to be about right.

Asian exports to the US appear to be just 18 per cent. But, the real amount, including all the “goods in process”, might be more than 30 per cent, he calculates.

I do not believe the de-coupling story. This is one of those pre-recession stories of hope that "the world has changed" when it hasn't. A US recesission will bite hard let there be no doubt.

Asia economies hope for happy divorce [FT]

Asia’s export-dependent economies are hoping that decoupling – the notion that the rest of the world can grow even with the US in recession – will hold true.

There have been signs. Over the past year, Japanese shipments to China have risen by 15 per cent, to Europe and other Asian nations by 11.5 per cent, and to the “rest of world”, including the oil-flush Middle East, by 25 per cent.

Still, exports to the US have been fading fast, down 1.7 per cent on the year, and because Japan’s eagerly awaited recovery in domestic demand has never materialised, its economy has been running on only one (export-led) engine. This fiscal year its economy is expected to grow by what analysts describe as a disappointing 1.3 per cent.

Peter Morgan, chief economist for Asia Pacific at HSBC, says that one of the chinks in decoupling’s armour is Europe.

The region has been happily sucking in Asian imports thanks to its strong currency and reasonably good economic performance. But as Asian currencies appreciate, against the euro as well as the dollar, and European economies slow, that will change. “That is going to take away one of the legs of the stool,” he says.

Exports to the Middle East, which accounts for a fairly modest but rapidly growing portion of Asian exports, should hold up assuming demand for oil stays firm. But the foundations of intra-Asian trade, on which much of the argument about export diversification rests, could be more rickety than they appear.

“One thing to remember is that a lot of exports to China are just passing through,” says Mr Morgan, referring to China’s role as an assembly plant for Asian components.

Asian exports to the US appear to be just 18 per cent. But, the real amount, including all the “goods in process”, might be more than 30 per cent, he calculates.

Thailand is a good example. Recent economic growth has been powered primarily by exports, about 12.5 per cent of which went directly to the US last year, down from about 20 per cent when the previous US recession struck in 2001.

Yet Thailand is not as insulated as this might suggest. Sethaput Suthiwart-Narueput, chief economist at SCB Securities, says Bangkok remains vulnerable to a US slowdown since most of its exports to China – about 9.5 per cent of total shipments, up from 4.4 per cent in 2001 – are components used to make goods bound for the US.

The picture is not black and white and decoupling is not an “either/or phenomenon”, says Paul Sheard, global chief economist at Lehman Brothers. Asia emerged relatively unscathed from the 1991 US recession but was much harder hit by the “tech recession” of 2001. Similarly, this time, depending on the precise nature of any downturn, commodity-rich Australia, Indonesia and Malaysia might fare better than, say, countries specialising in electronics, such as Taiwan or South Korea.

Indonesia, for example, has already noticed its non-oil and gas exports slowing to the US. Mari Pangestu, trade minister, told the Financial Times: “Our strategy now is to diversify markets and diversify products. We think the growth market is still Asia, although if the US does fall into recession it will have an impact on the high-growth economies.”

The US remains India’s largest export market, reducing the country’s chances of surviving a US downturn unscathed. The Reserve Bank of India says it has already seen a slowdown in the crucial software and services exports.

By contrast, Australia’s reliance on US exports has substantially diminished. Tim Harcourt, chief economist at the Australian Trade Commission, points out that the US share of Australia’s exports has fallen from 10 per cent to just 6 per cent as “Australia has benefited from the global economy firing on more cylinders than usual.”

China and the health of its economy could be a key factor for many others in Asia. If China’s role as the world’s assembly plant is vulnerable to a US downturn, its infrastructure-led demand is less so. Barring the truly unexpected, even a US recession is not likely to push Chinese growth much below 9 per cent, against 11.4 per cent last year.

Depending on the components of that growth, there could be more demand for, say, raw materials and construction equipment and less for components and factory machinery.

That could slow, but not throttle, growth in some Asian economies. For example, both Singapore and Malaysia have seen a slowdown in their biggest export category, electronics.

But, according to Kit Wei Zheng, a Citigroup economist, Singapore is unlikely to suffer as big a slump as in 2001 because it has diversified into other export areas, including pharmaceuticals. Likewise, Malaysia is partly cushioned by the global demand for palm oil.

Diversification will only go so far, however, particularly if US consumption nosedives, says Mr Sheard. “Asia, centred on China, has become even more interlinked into the global economy, the driving impetus of which has been the US,” he said. It is hard to be global and decoupled at the same time.

Exactly.

.

Has China's growth peaked?

This is the question that the FT ask in today's paper. Again, this is not a surprise and most economists would forcast a reduction in growth this year to perhaps single digit.

A US recession would not help. Even though the US and EU do not take the majority of exports from China, even exports to China's ASEAN neighbours will fall as they themselves depend on exports to these regions.

The saviour has to be domestic demand. However, although there is no doubt that the Chinese middle class is growing strongly, poverty levels are still very high, disposable income low and savings rates high.

China’s economic growth passes its peak [FT]

Behind the headline forecasts of decelerating Chinese output in 2008 lies a more significant trend that may mark a long-awaited turning point for the economy and its global impact.

Chinese and World Bank economists have significantly downgraded forecasts for China’s national growth in recent weeks – from 11.4 per cent in 2007 to maybe two percentage points lower this year.

But more importantly, the 11.4 per cent expansion in 2007 – the fifth consecutive year of double-digit increase – could represent the peak in headline growth for China for the foreseeable future.

In short, thanks to slowing global and US economies, China may never be able to grow as quickly again as it did last year.

So is this bad news? Far from it. This "breather" might be just what China needs especially given environmental considerations.

The Chinese government, far from being alarmed at such a turnaround in growth, would largely welcome it.

The slowdown could dovetail with Beijing’s own aims to moderate the contentious trade surplus and, at the same time, recalibrate growth away from heavy industry in favour of consumption and services.

“If China is able to rebalance the economy, making it less intensive in resources and capital, cleaner and more widely shared, growth of 9-10 per cent a year for long periods would be the [outcome] developing countries across the world are looking for,” said Louis Kuijs of the World Bank in Beijing.

The surge of recent years in investment in heavy industry, such as steel, aluminium and cement, has strained energy resources, contributed hugely to greenhouse gas emissions and pollution and created few jobs.

Such a cocktail is anathema to Chinese leaders, who face pressure at home to create more jobs – especially with exports in relative decline – and from abroad to tackle carbon emissions.

China Financial Markets also has a take on the effect of a US recession- the title gets straight to the point. Pettis agrees with me (or I agree with him) on decoupling.

A US slowdown won’t help China [China Financial Markets]

../

Last time I was here, in July, a lot of people asked me about the “decoupling” thesis, and not everyone was terrible pleased (or in agreement) when I said I thought the idea was mostly nonsense, based partly on mistaken premises and partly on wishful thinking.

Now, it seems, no one takes the idea of decoupling seriously at all. Everyone is convinced that a sharp slowdown in the US will be disastrous for the rest of the world. This is one idea whose death seems to have come quick and hard. In fact, the most noticeable aspect of my trip here is the sheer gloom and worry about the state of the US and world economy. It has been a while since I have seen so much pessimism and nervousness.

../

Talk of rising inflation and a slowing economy brings us straight back to the topic of China. Xinhua yesterday reported that the “U.S. slowdown could be opportunity, not crisis, for China.” They report that a number of Chinese economists believe that a US slowdown, by reducing the growth rate of exports, could help rebalance Chinese growth, towards a healthier mix of investment, exports and consumption and would help relieve monetary expansion.

To their credit few Chinese have taken the decoupling thesis very seriously, but if they expect a US slowdown to help resolve their domestic problems I think they are missing the point. One economist mentioned in the article, Zheng Jingping, a researcher with the National Statistics Bureau, did get focus on the key issue when he noted that “it was not export growth but the trade surplus that would be the key issue”. This is exactly right. If China’s exports decline, and Chinese imports decline also so keeping the trade surplus high, China will get hit by a double whammy. The reduction in exports will hurt economic growth but the high trade surplus will keep China’s furious money expansion going, so continuing to put upward pressure on investment and industrial production. The “rebalancing” would consist of an even greater share of investment as part of total GDP growth. This would be a worst-case outcome.

Could exports slow while causing a decline in imports? Yes, in fact it is highly likely. Remember that nearly half of Chinese exports are recycled imports, and any slowdown in the very important and lively export sector might indirectly affect Chinese overall consumption by increasing uncertainty. But even if there is a small decline in the trade surplus, that is not enough. In order to halt the money-creating monster that China’s currency regime has become, we need the trade surplus (and hot-money inflows) to decline substantially.

Exactly.

World Bank sees lower growth in China

Given the state of the world economy with predictions of country specific recessions (US) and a general global down turn the World Bank are not exactly going out on a limb predicting a slow down in China.

The de-coupling theory never held water in my opinion although the Chinese economy is beginning to generate its own momentum based on domestic demand and consumption. However, getting the savings rate down will still be difficult.

World Bank forecasts slower China growth [FT]

The World Bank on Monday scaled back its projection for Chinese growth and raised its forecast for inflation but said Beijing was in a strong position to stoke demand if the global economy turns down sharply.

The bank said in a quarterly update that it now expects gross domestic product to expand 9.6 per cent in 2008, which would be the slowest growth since 2002.

In its previous report in September, just as the global credit crunch was intensifying, the bank projected 10.8 per cent growth in 2008.

“Given the current uncertainty about the global outlook, the risks are larger than normal, especially the downside risks,” the bank said.

But the lender’s Beijing economists said China was well placed to cope with a moderate global slowdown thanks to robust domestic fundamentals, including high profitability and improving consumption.

“China enters 2008 with very strong momentum in the domestic economy,” Louis Kuijs, senior economist told a news conference.

China could easily pump up the economy further if needed by relaxing fiscal policy – China has a tiny budget deficit – or by easing credit curbs that the central bank has been enforcing to prevent overheating.

“Inflation concerns make lowering interest rates or relaxing liquidity management less obvious. Uncertainties in the outlook call for vigilance and flexibility,” the report said.

The bank now expects consumer prices to rise 4.6 per cent on average this year, up from 3.8 per cent projected in September.

Inflation in the year to December was 6.5 per cent, close to an 11-year high, and financial markets suspect the rate will top 7 per cent in January and February because of food shortages caused by the worst winter weather in 50 years.

The bank expects the impact of the fierce weather on output and prices to be temporary and says inflationary pressures should ebb later in the year, not least because the rate of increase in international food prices will slow.

But there were also upside risks to inflation from higher land use fees, cuts in export tax rebates and the costs of complying with new labour laws, the bank said.

It said the global slowdown could have a silver lining for China by helping to reduce the economy’s reliance on exports, which have grown much less rapidly than imports in recent months.

The bank expects China’s current account surplus, the broadest measure of trade, to fall to 9.3 per cent of GDP this year from an estimated 11.0 per cent in 2007.

“We may be closer to a moderation in the growth of China’s trade surplus,” Mr Kuijs said.