China's economy set to achieve soft landing

Frances Cheung, China Daily, Asia News Network, Beijing

In recent months, debates have sprung up on whether China's economy is overheated, and then on the possibilities of a soft or hard landing.

China can attain a soft landing, given non-exceptional fast growth in a developing stage and benign inflation. The authorities also must issue policy differentiating between and targeting specific sectors when curbing credit.

An overall increase in interest rates is not the most appropriate policy action at the current stage.

Admittedly, overheated investment is occurring in sectors such as steel and cement. But what China wants is not a sudden braking in all sectors where China needs the products.

China would like to avoid a boom preceding busts.

Last month the State Council sent a special group to investigate the construction of a 10.6 billion yuan (US$1.27 billion) iron project in the cities of Changzhou and Yangzhong in East China's Jiangsu Province. Police detained the managers of the steel plant for allegedly illegal expansion.

In this situation, the country maintained its plans of further boosting steel production capacity. It shows China still welcomes high-quality expansion projects. An overall interest rate hike cannot attain this selective targeting.

That is why China turns to administrative measures when trying to curb unwanted expansion.

The authorities identified certain overheated sectors, namely cement, steel, auto, real estate and aluminum, where new bank loans are to be placed under stricter scrutiny. These measures will take effect gradually. Renminbi loans, broad measurement of money supply, or M2, and fixed asset investment growth have all slowed down recently.

The fear of inflation has prompted analysts to anticipate or suggest a rate hike. However, inflationary pressure remains mild at present.

First, consumer prices inflation is now around 3 to 4 per cent, far below the 20-odd per cent during the last bubbles in the early 1990s. Moreover, consumer price inflation is now driven mainly by surging food prices. Non-food inflation is below 1 per cent. China is comfortable with this as it redistributes income to the poor rural residents.

Input prices, in particular raw materials prices, have been rising more rapidly than final products prices, squeezing corporations' profit margins. Facing intense competition, enterprises can shift only part of the surge in increasing prices to their customers.

A recent report from the Ministry of Commerce indicated that nearly 80 per cent of China's consumer products are over- supplied. Over investment is already sowing the seed of future deflation. An inappropriate increase in interest rates will risk dragging the economy back to a deflationary environment which China had been trying to escape for a long time.

Moreover, income growth is lagging far behind investment growth. Every year there are 10 million young urban residents entering the labor market to compete with millions of migrant farmers. This adds to the difficulties of corporations raising products prices.

On the other hand, the impact of a rate hike on credit growth is doubtful.

In China, banks' lending procedures are not strict enough. Local governments have a lot of influence on banks' granting of loans for projects. The performance of local officials is assessed through the growth their regions attain, and thus they have been rushing to start large infrastructure projects.

Aggregates of provincial GDP data have always been higher than the national GDP level, reflecting how eager provinces are to boost their output. Loans are not granted on a risk-assessment basis anyway, so why should they be curbed by upward movement on lending rates?

Conventional monetary policy tools may not work as one expects because interest rate transmission mechanisms have not been in place for long enough yet.