Chinese Economy: Current Issues and Future Scenarios FAN Gang National Economic Research Institute China Reform Foundation November, 2004

Trends or Scenarios: Short-run: possible soft-landing: Government took actions much quicker; Long-run: Possibility of high growth for another decade—fundamentals are still favorable.

Short-run Growth Cycles

There has been a Over-heating again

The main contributor: Investment Boom

Why should (Chinese) economists worry about? Potential growth rate: 8-9%; Early find-tuning to stop the acceleration! The economy is vulnerable to the fluctuations;

A nice Soft-landing is highly likely Government was quite quick to respond, so the over-heating was not fully developed; Realistic policies, including administrative ones; No hard-landing, if policy-making with normal wisdom.

What will be the next? With the growth rate back to the zone of 8- 9%, China may continue the current boom for next 2-3 years; While macroeconomic stability stays, more reforms will take place: banking, capital market, taxation…..

Long-Run Development

China is full of Problems and difficulties: Two Sets Set I. As a developing country -- Per capita GDP US$1,000 by 2002; 65% of population are rural. * Industrialization * Modern corporate system * Financial market development * Rule of law * Rural-urban difference and urbanization * Regional disparity and migration * Opening and competition * Unemployment: various categories * Democratization …………

Set II. As the economy in transition -- Legacy of Soviet-type system, currently 80 millions working as state employees. * The state owned enterprise (SOEs) * The state banking system * Social security system * Planning to Market * Government reform and political changes ……

Achievements or Reasons for Achievements No longer as a State company dominated economy (up to 70% of GDP comes from Non- state sectors, most of small SOEs privatized); Opening up (trade and FDI, WTO); Decentralization of decision-making and diversification of society.

Major concerns There are many concerns about if China’s growth would be interrupted by any kind of crises or upside downs. 2 biggest selected: –Financial crisis: NPL, etc, –Social crisis: Unemployment and social instability;

Financial Risks Financial Reform is seriously lagged behind as a bottleneck; Foreign participation may cause financial difficulties for the state banks, but may improve the overall quality of financial assets, and therefore reduce the risk; For the state banks, the NPL risk is still manageable.

Unemployment and Social Stability

Basic facts: 25 millions of state workers were laid off in past 5-6 years; 6 millions still unemployed; at least 20 mil. More to come. 45% of labor force, or 350—400 millions, are still dependent on farming, mostly under- employed; 15 millions new non-farming jobs created by 7- 8% growth per year;

Why is still there the social stability Special programs for the laid-off state workers; New job creation by the growth; Improvement of labor mobility; Rural land system serving as China’s special social security for the rural unemployment;

The realistic policies: Prepared to go through a painful historical process of modernization; Do not raise the expectations for the government subsidies; Do more for education within the budgetary affordability; Increase gradually the medical protection of the rural poor.

Foreign Exchange Issues Most South-East Asian currencies have been floating after 1997; But China was forced to return to fixed regime since then.

Market speculation still strong

Revaluation seems less urgent in past months: -- Overall trade balance; -- Inflation is increasing; -- Uncertainty about the oil price and its impacts; -- US$ was not fast weakening until recently

The real Issues: How to de-peg from US$, and change to a basket-pegging system with higher flexibility? – That is China’s self-interest, not others’. How to minimize the speculation; How to catch up the good opportunity in the market to do so?