China needs new credit system

Li Enqiang, China Daily, Asia News Network, Beijing

The economy is plagued with over-supply of products which do not sell well, the rational policy choice should be to upgrade industrial structure. It is quite inaccurate to describe the current economic situation as "deflationary."

True, the domestic demand is not dynamic, but the price of consumer goods is going up, though only marginally.

But as the overall narrow and broad measurements of money supply see a growth of about 20 percent, deflation is certainly not the proper word for the situation. It is hasty to jump to the conclusion that we are in a period of inflation or deflation simply because of price fluctuations.

The consumer price index and the retail price index are not fully reliable tools to measure economic sentiment on a macro level.

In recent years, the Chinese have been spending an increasing proportion of their incomes on services such as education, transportation and communication.

Though the price of services keeps growing, it accounts for less than 12 percent in the calculation of the consumer price index and the retail price index.

But if we take into account the change in consumer expenditures, especially the increase in educational expenditures, the prices of services and housing can be given 2-4 percentage points more proportion in calculating the consumer price index.

The national consumer price index in 2002 would rise by 0.1 to 0.4 percent year-on-year instead being seen as a drop of 0.8 percent. And the same index for the first eight months of 2003 would also show a growth of more than 1 percent.

The unreasonably low percentage of service price in the index calculation makes the indices susceptible to food price alterations and unable to mirror the economic situation as a whole.

The constant drop in prices of consumer goods should not be attributed to inadequate demand in and outside the country. Instead, it is caused by the structural imbalance of supply which does not match need.

Adequate proof can be found in the excessive supply of unsold products and imports, which is then interpreted as drop in demand. The price will not recover to a normal level if the supply situation is not upgraded by market force throwing incompetent producers out of the market.

To achieve a balance of supply and demand, new reforms must be adopted. Such reforms should aim at establishing a share-holding system in state-owned enterprises.

For example, this summer, the Beijing municipal government invited private and foreign investors to invest in 104 State- owned enterprises. This is a signal that there has been a substantial change in the ownership system. Treatment like this may have side effects. Money may be tunneled into individuals' pockets through improper means. But such negative effects can be checked by the establishment of an effective legal framework.

Development of real estate, iron and steel production and automobiles could be an easy fix to accelerate demand growth. But along with their growth, one should not ignore the increasing stockpile of industrial products and the mounting import of advanced technologies and high-tech merchandise.

In the past decade, one of the major causes for sluggish consumer demand is that bank loans are not granted to those who are really in need. Small private investors have a hard time getting capital from financial institutions to initiate or expand their businesses.

Farmers are in a similar, or even worse, situation; financial institutions are reluctant to give them credit. To help the economy advance smoothly, a fundamental cure is to establish a credit system both for enterprises and individuals in this country.

This system can help promote the awareness of social trust, which is an important condition for the success of the government's efforts to stimulate demand and increase employment.

Many of the administrative endeavors will be to no avail if dishonest business decisions and practices are rampant.

When an appropriate system and laws are established, loan receipts issued by businesses can be used as an effective tool in controlling monetary supply, hence bolstering the effectiveness of the central bank's policy on stimulating domestic demand and rationalizing the structure of industrial production.

The author is a researcher with the Research Institute of Macroeconomics under the State Development and Reform Commission.