China became the world’s second largest economy in 2010; increasingly, it is playing an important and influential role in the global economy. The discussion now tends to focus on how China can avoid “the middle-income trap,” as experience shows that transitioning from middle-income to high-income status can be more difficult than moving up from low to middle income.
Yet, with a per capita gross national income of about US$3,650 (2009), China is a lower middle-income country that has complex development needs. With the second largest number of consumption-poor in the world after India, poverty reduction remains a fundamental challenge. Rapid economic ascendance has brought on many challenges as well, including demographics – issues related to an aging population as well as the internal migration of labor; high inequality; rapid urbanization; challenges to environmental sustainability; and external imbalances. Significant policy adjustments are required in order for China’s growth to be sustainable.
In its 11th Five Year Plan (2006 - 2010), the Government of China set forth a “people centered” strategy aiming to achieve a “harmonious society” that balances economic growth with distributional and ecological concerns. Under this plan, considerable progress was made in improving basic public services in social protection, education and health, but structural issues remain under the strong momentum of China’s traditional pattern of growth.
The 12th Five Year Plan (2011 - 2015), recently approved by the National People’s Congress, comes at a time when the need to rebalance toward a more domestic demand-led, service sector-oriented pattern of growth is stronger than before, partly due to the less favorable global outlook.
The Plan has set five main objectives:
Maintaining stable and fast economic growth, with a focus on price stabilization, more job creation, improved balance of payment, and higher quality of growth. Achieving major progress in economic restructuring, with higher share of household consumption and the service sector, further urbanization, more balanced rural-urban development, lower energy intensity and carbon emissions, and better environment. Increasing people’s incomes, reducing poverty and improving the living standards and quality of life. Expanding access to basic public services, increasing the educational level of the population, developing a sound legal system, and ensuring a stable and harmonious society. Deepening the reforms in the fiscal, financial, pricing and other key sectors, changing the role of the state, improving governance and efficiency, and further integrating into the world economy.
China’s economic growth has remained resilient as the macro stance moved towards normalization. Both fiscal and monetary policy contributed to the normalization. Consumption growth slowed in early2011. But overall domestic demand held up well, supported by still strong investment growth. Realestate investment has so far remained robust to measures to contain housing prices—a policy focus.Reducing inflation is the other policy priority, after inflation rose to 5.4%, largely on higher food prices.
The economic outlook remains broadly favorable. The global growth outlook has so far been little affected by the higher raw commodity prices and the earthquake in Japan. Domestically, headwind from a normalized macroeconomic stance, inflation, and somewhat slower global growth is likely to be partly offset by solid corporate investment and a still robust labor market. An expected slowdown in mainstream housing construction should in part be compensated by the government’s ambitious social housing construction plans. With a broadly neutral contribution of net trade, we now project China’s real GDP growth at 9.3 percent in 2011 and 8.7 % in 2012. The surge in raw commodity prices means we expect another decline in the current account surplus this year. However, whether the trend towards a lower external surplus and lower dependence on external trade will be sustained remains to be seen.
A fully normalized macro policy stance is key to address the macro risks with respect to inflation and the housing market. With food price increases slowing, sequentially, and core inflation still in check,inflation should moderate eventually. However, much of the impact of the higher oil and industrialcommodity prices is still in the pipeline, inflation expectations are high and there is little spare capacityin the economy, overall. To address the risks on inflation and the property market, macro policy istypically better placed than moral suasion and administrative measures. It is too early to stop the macrotightening. Two way risks are better dealt with by maintaining fiscal and monetary flexibility.
While the macro and financial risks on the property market require macroeconomic measures and reforms, social concerns require a different policy response.Macro and financial policy is supposed toprevent different types of risks from building up and make the economy and the financial system robustto a possible property downturn, rather than mainly focus on containing overall housing prices. Ifhousing prices are considered systematically too high from a market perspective, macroeconomic leversare more obvious than administrative measures, especially locally administered ones. On the otherhand, making housing more affordable for targeted groups requires sustainable rules-basedarrangements, almost unavoidably explicitly subsidized by the government. The scaling up of socialhousing is in the right direction. However, finding a transparent, rules based financing model is key.
The 12th 5YP can provide direction for reform.Its two key overall objectives are rebalancing and industrial upgrading and moving up the value chain in manufacturing. Policy-wise, it is important to find the right balance between these two. With regard to the 5YP’s growth targets, the challenge is to make them binding and consistent nationwide. The targeted 4 pp of GDP increase in the share of services is ambitious but supported by fruitful policy proposals. The targeting of wage growth at or above GDP growth is new. Reforms of inter-governmental fiscal relations will be crucial for achieving meaningful progress on a range of other policy priorities. Barriers to labor mobility may require more attention.
Exports slowed down in late 2010 but continued to expand in early 2011. As world trade rebounded in the first half of 2010, China’s exports surged 39% (SAAR) in real terms. In the second half, amidst slower world trade growth, exports rose only 7% on this sequential metric, but in the first quarter of 2011 they expanded 10.6% (SAAR), to a level up 11.4% on a year ago in real terms.
Reflecting the still robust overall domestic demand, imports held up well early this year, especially those of manufactured goods.Overall import volumes rose 14% in the second half of 2010 (SAAR), withgrowth particularly strong in the fourth quarter. They broadly kept that pace in the firstquarter, growing 13% (SAAR) to a level up 14.5% on a year ago. Processing imports volumes continuedto track processing export volumes, while growth of “normal” imports—used in the domesticeconomy—slowed from 22% to a still solid 15% (yoy) in the first quarter, in real terms. As in most of2010, manufactured goods imports outpaced raw material imports substantially (yoy), in real terms.
Falling external terms of trade combined with the volume developments to lower the trade surplus. For much of 2010, net external trade contributed positively to GDP growth. The NBS estimates thiscontribution at 0.8 percentage point (pp) for the whole year; our estimate is 2.5 pp.However, a large decline in the external terms of trade—as global commodity prices recovered muchfaster than those of manufactured goods—kept the trade surplus broadly unchanged in 2010, in USdollar terms. Nevertheless, the current account surplus rose, largely because of higher incomeon China’s rapidly rising foreign assets.3 In the first quarter of this year, with export volumes slowingmore rapidly than import volumes, the contribution of net trade to real growth declined—we estimate itwas slightly negative (yoy). On the back of further raw commodity price hikes in the first quarter, theterms of trade were down another 3.8% on a year ago and the (customs data based) trade balanceshifted to a small deficit, although the seasonally adjusted trade balance remained positive.
Inflation has risen to a 32 month high on higher food and other raw commodity prices.Consumer price inflation rose to 5.4% (yoy) in March, mainly driven by higher food prices caused by problematic weather domestically last year and hikes in international food prices. Vegetable prices, the key driver in 2010, have come down recently, sequentially, after peaking in February. Retail prices of other food products, such as meat, rose in the first quarter, probably driven by higher feed costs.5 Grain retail prices have also risen, in line with adjustments in procurement prices. However, overall, pressure from food prices may have peaked for now, with sequential increases having slowed since early 2011. In the absence of significant spill-over into other prices and wages, underlying inflation pressures have so far remained low. Core inflation was 2.3 percent in March (yoy), although much of the impact of higher raw commodity prices is still in the pipeline.
The government has taken several steps to contain inflation. In addition to normalizing the overall macro policy stance it took some measures to boost food supply and reduce the cost of production and logistics, including releasing grain from China’s large reserves, increasing subsidies to farmers, exempting transport of vegetables from road toll, and boosting food imports. More recently, this was followed by limiting the increase in domestic fuel prices arising from higher oil prices and applying moral suasion on manufacturers of food and consumer products. Also, after being de facto pegged for almost 2 years, since June 2010 the RMB has appreciated 4.6% against the US dollar, although it depreciated in nominal effective terms.