Praying for a soft landing in China: Maley

Is China heading for a “soft landing”?

That’s the hope of some China watchers, particularly after data released yesterday showed that activity in the country’s factories picked up slightly in August, despite sluggish demand for China’s exports.

China’s official purchasing managers’ index climbed to 50.9 in August, from a 28-month low of 50.7 it hit in July. The country’s manufacturing sector has borne the brunt of measures introduced by the Chinese central bank aimed at cracking down on inflation.

Optimists say that the latest figures show China’s manufacturing sector is stabilising despite being squeezed by Beijing’s inflation-fighting measures, and a decline in demand for Chinese exports.

But critics argue that China’s central bank has not done enough to tackle the growing inflationary pressures, even though it has lifted interest rates five times since last October and has progressively hiked banks’ reserve requirements (the amount of money that the banks are required to hold on deposit with the central bank).

They argue that the interest rate rises have barely kept pace with inflation, which climbed to a three-year high of 6.5% in July. And they argue that the increase in the bank’s reserve requirements merely offsets the liquidity that floods into the country as a result of China’s efforts to keep its exchange rate steady.

In their view, the latest PMI figures confirm that inflationary pressures are continuing to build in China, with factories being forced to pay higher prices for inputs such as raw materials and intermediary goods.

But the Chinese leadership appears determined to continue with its existing policies, as it tries to rein in inflationary pressures without causing the Chinese economy to contract too sharply.

Earlier this week, Chinese Premier Wen Jiabao signalled that fighting inflation remained the Chinese government’s top priority. In an article published in Qiushi, a key journal published by the ruling Communist Party on Thursday, Wen said “We must try our best to bring about a bigger drop in inflation in the second half of this year and lay a foundation for price controls for next year.”

At the same time, Wen conceded that Chinese firms faced increased pressures from rising labour costs, higher interest rates and a firmer yuan. As a result, he said policies must be prudent to avoid harming the real economy.

But there is growing pressure on the leadership to embrace more deep-rooted structural reforms. In a strongly-worded opinion piece published in the Financial Times, the head of the World Bank, Robert Zoellick, argues that China’s leaders realise the country’s existing growth model is “unsustainable”.

Zoellick points out that for the past 30 years, China has enjoyed average annual growth of about 10%. “In 1990, its income per capita was 30% lower than the average for Sub-Saharan Africa – today, it is three times greater, over $4,000. By 2030, if China reaches a per capita income of $16,000 – a reasonable possibility – the effect on the world economy would be equivalent to adding 15 of today’s South Koreas.”

But, he adds, “it is hard to see how that expansion could be accommodated within an export and investment-led growth model, so China will need to rebalance through boosting domestic demand, lowering savings and increasing consumption”.

Without fundamental structural changes, Zoellick warns, “China is in danger of becoming caught in a “middle income trap” – exacerbating the world’s growth problems.”

In the short-term, Zoellick argues, China faces the risk of inflation driven by rising food prices. Longer-term, he warns, “the drivers of China’s meteoric rise are waning: resources have largely shifted from agriculture to industry; as the labour force shrinks and the population ages, there are fewer workers to support retirees; productivity increases are declining, partly because the economy is exhausting gains from the transfer of basic production methods.”

In addition, he says, China faces other challenges “including serious environmental degradation; rising inequality; heavy use of energy and production of carbon; an underdeveloped service sector and an over-reliance on foreign markets.”

China’s policy makers, he argues “are well aware of “what” they need to do. Their 12th five-year plan points the way. Their challenge now is ‘how’ to do it.”

This article first appeared Business Spectator.