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Credit stimulus not panacea

By Xiao Gang  (China Daily)

09:15, July 23, 2012

Efforts should concentrate on upgrading industrial structure and increasing government spending on public services

It is very clear that Chinese economy is slowing substantially. The Purchasing Managers' Index, a key gauge of manufacturing, fell to 50.2 in June, and other indicators, such as electricity consumption, rail cargo volume and the M1 measure of monetary supply, suggest that the economy is still facing downward pressure.

Against this backdrop, China has begun to implement fine-tuning measures to stabilize growth, while continuing to implement a proactive fiscal policy and a prudent monetary policy. Obviously, there is an expectation that we might see a return of the 2009-style credit spree to boost the economy.

In reality, the slowing of the Chinese economy at that time had begun in 2007, before the onset of the global financial crisis, partly due to a number of constraints on growth potential, for example, the increasing costs of labor, land and environmental protection. Meanwhile, at that time, in the face of inflation, a tightening monetary policy was adopted. That is to say, even without the global financial crisis, the time would have come for China to slow its growth after experiencing many years of rapid expansion.

However, the global financial crisis trapped the Chinese economy amid a weak external demand and a worsening slowdown, so it was extremely important and reasonable for China to launch a massive 4 trillion yuan ($628 billion) stimulus package in 2008, effectively helping China sail through the crisis and stabilizing the world economy over the past two years.

Now things have changed greatly. It was right to expand credit to boost investment in 2009-10, but this time a massive credit stimulus should not be regarded as a solution.

The new bank loans made during 2008-10, equivalent to 60 percent of GDP in China, fueled an investment boom; as a result, investment rose from 42 percent of GDP in 2007 to 49 percent in 2010 and 2011. This high investment rate is definitely unsustainable. A true change in the old economic development model relying heavily on investment and exports will only be possible if the credit-hungry economy is adjusted.

Usually, fast credit growth can boost economies by stimulating supply, but the current problem in the Chinese economy is not on the supply side, it's the lack of demand, especially final consumption demand.

There is no doubt that there is already an overcapacity in industries such as steel, automobiles and construction materials, leading to lower prices, a big drop in profitability and higher inventories. Under such conditions, a repeat of 2009/10's massive lending might provide a short-lived boost for the economy, but it would not really help these industries, rather, it would saddle the economy with problems of further overcapacity in the future.

It is worth noting that the investment boom of 2009-10 was mainly concentrated in infrastructure and real estate property, raising inflation expectations and housing prices. Given the importance of rebalancing the Chinese growth pattern, it does not seem appropriate to take the old path of a bank credit-based stimulus. Instead, policies should be shifted to concentrate on upgrading the industrial structure, and expansionary fiscal measures should raise government spending on health, education and pensions.

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