China’s budget should calm investors in three ways

March 7, 2011

By Wei Gu
The author is a Reuters Breakingviews columnist. The opinions expressed are her own.

HONG KONG — Chinese premier Wen Jiabao’s weekend “state of the union” speech should calm investors in three ways. Wen pledged that growth would become more sustainable thanks to a focus on social welfare.

Liquidity should be boosted by higher government spending. And if both fail to impress, record expenses on police and domestic surveillance should help contain the risks of dissatisfaction.

Investors’ worries about inflation, tightening and social tensions have left the Shanghai Composite Index flat for three months. Wen’s speech gave it a 2 percent boost on March 7. His 2011 budget targeted a few key numbers: 4 percent inflation, 7 percent income growth, and 10 million new affordable homes, all clearly aimed at keeping the masses happy.

The focus on welfare is sensible. Inequality adds to China’s political risks. Income disparity, as measured by the Gini Index, surpassed the warning level in 2007 and is worse than any developed economy, according to the World Bank. Income growth should also help China move from investment-dependency to consumption, a more stable form of economic growth.

Expansionary fiscal policy to finance social projects should keep GDP growth above 8 percent, and ensure enough liquidity to shore up asset prices. Central government fiscal expenditure in 2011 will rise by almost $1 trillion, or 13 percent, from 2010, versus a 10 percent increase in 2010. The Shanghai Composite tends to do well when public expenditure picks up.

Wen’s targets won’t be easy to hit. Income growth has persistently lagged GDP, trailing by 1.9 percentage points during 2006-2010, according to official data. Even if authorities turn that around, higher minimum wages may add to inflation and hurt employment. Meanwhile, the social housing plan looks too ambitious. China aims to start almost as many affordable homes in 2011 as in the previous five years put together.

That’s where security spending comes in. Spawned by unrest in Egypt and Libya, spending on police and domestic surveillance is set to jump 14 percent to new heights this year, outstripping the defence budget for the first time. That’s by no means good for those who would hope for democracy in China, but should soothe the nerves of those who just want a more stable financial return.

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