Market must adjust itself


Updated Thu, 29 Jul 2004 00:00:00 GMT

China's financial authorities apparently found a way to make the nation's economy land softly, but they failed to figure out how to let the market adjust itself.

Instead, they continue to use their administrative powers to adjust the nation's rapidly expanding market.

National Bureau of Statistics (NBS)'s figures indicate China's fixed-asset investment grew 42.8 per cent in the year's first four months.

While the expansion was fast, it was 5 percentage points below the figure posted in the year's first quarter.

More important, fixed-asset investment in China's urban areas -- which have absorbed substantially more investments than the rural areas -- grew 34.7 per cent in April, down 8.8 percentage points compared with March.

Taking other signs -- including shrinking bank loans, slower growth in real estate investment and price drops in raw materials -- into consideration, most experts would agree the Chinese Government has done a good job cooling off the overheated economy.

But how did China's authorities manage that feat so effectively and so fast?

One possible reason: The government used its administrative power to adjust the macroeconomy, and those efforts might not have been so effective had the market functioned well on its own.

Indeed, the overheating economy was the result, at least in part, of the ballooning number of investment projects sponsored by or affiliated with local governments.

The central government's tightening measures -- including the issuance of policy guidelines to local governments, urging them to suspend ongoing investment projects -- were effective.

But economic demand for such investment projects, or basically supplies of energy, power and raw materials, were merely put on hold. That means, in essence, investment fever will resurface in the future.

Assuming most of these investment projects are initiated by the private sector, the government's policy guidelines and/or administrative power will play a minor role, and the central bank will probably raise interest rates.

China's economy showed early signs of overheating in June 2003, almost a year after fixed-asset investments started to soar.

The economy's abnormal expansion could, in part, be the result of the government's measures to stimulate the economy as it tried to shake off the negative effects of the severe acute respiratory syndrome (SARS) outbreak early last year.

The People's Bank of China (PBOC), the nation's central bank, began tightening credit and mopping up the system's excess liquidity last September, as decision-makers were aware the economy was overheating.

NBS' figures indicate the economy cooled down a bit after the government implemented the credit tightening measures. The economy grew slightly slower in the last quarter of 2003.

But it remains to be seen if NBS' figures actually reflect the macroeconomic situation, as local governments tend to provide the central government with statistics that seem to prove they comply with central government's policies.

It is possible many local governments, rather than eliminating such investment projects, temporarily suspended the initiatives until this year, so they would fall under China's new fiscal year. As a result, the economy expanded far beyond policy-makers' expectations.

Under a market economy, the government should avoid directly interfering with market functions, but should use fiscal and monetary policies to manage macroeconomic adjustments.

The Chinese Government has long been hooked to expansionary, or proactive, fiscal policies, while the central bank's monetary policies have not been as effective as many outsiders have suggested.

Since the Asian financial crisis in 1997, the Chinese Government has used a proactive fiscal policy as an engine to spur economic growth.

China since 1998 has issued 910 billion yuan (US$109.6 billion) worth of State bonds, including 110 billion yuan (US$13.3 billion) this year.

This staggering amount, combined with complementary bank loans, has almost reached 5 trillion yuan (US$602.4 billion) in the past six years. That has contributed 2 percentage points to China's annual GDP (gross domestic product) growth.

China's monetary policies have been effective in slowing the red-hot economic growth, and liquidity in the system will be adequate if the interest rate is reduced moderately. But if PBOC adjusts the benchmark interest rate by a large margin, the economy must land hard.

Indeed, PBOC, since late last year, has cut the interest rate for commercial lenders' deposits with the central bank and raised reserve requirements for banking firms.

The effects of the actions, however, seem to have been softened as China's commercial lenders are still highly liquid, due in part to residents' growing deposits and hot money from overseas.

Furthermore, the Chinese Government must slow down the investment growth in the real estate sector before constraining investments in other sectors -- including steel, aluminium and cement.

Otherwise, surging demand in the real estate sector will result in another investment hike in the related sectors, and China's economy will overheat again.

In the current situation, price levels in China's real estate sector should be an effective gauge of how well the country's macroeconomy is adjusted.

Overinvestment in the real estate sector is the main contributing factor in the current round of economic overheating. It pushed up price levels in other sectors -- including steel, aluminium and cement.

The unexpected increase in production within these energy-consuming sectors caused price hikes in oil and electricity shortages nationwide.

Investments in China's real estate sector last year soared to 1 trillion yuan (US$120.85 billion), up 29.7 per cent year-on-year. That was the fastest annual growth since 1995.

Outstanding bank loans to the real estate sector rose to 665.74 billion yuan (US$80.45 billion), a year-on-year increase of 49.1 per cent.

Since the real estate industry has become the leading engine of economic growth in many Chinese cities, the central and local governments have been unwilling to constrain the sector's growth.

As a result of the Chinese Government's efforts to adjust the macroeconomy, the growth of the country's real estate sector will likely slow down within two years.

For this year, however, growth in the real estate sector will continue, which will push the growth of China's GDP over 10 per cent.