China needs to be bold to ride out the storm
Beijing risks inflicting even more damage to the world economy by reflexively slowing market reforms in response to the financial crisis. But China’s leaders should quicken, not slow, the pace of reform to help it ride through the storm.
This December marks the 30th anniversary of China’s decision to embrace market liberalization but with growth becoming the No.1 concern in China, reforms have taken a back seat.
To stimulate the economy, Beijing has resorted to non-market measures that have worked in the past, such as building big infrastructure projects to boost public spending.
Further, the yuan’s recent slide has prompted some market-watchers to speculate that policymakers are deliberately encouraging the depreciation of the currency to support exports.
But those policies will not pull China out of this turmoil. The multiplier effect of government infrastructure investment is much weaker than during the Asian financial crisis because China’s roads and bridges are much improved. And with demand slumping almost everywhere abroad, a small yuan devaluation will not save exports, especially when the currencies of other Asian nations are seeing much bigger falls.
China has to switch from its export-oriented growth model to a new one driven by domestic demand.
To that end, Beijing should introduce further reforms, such as improvements to the social security net, reforms on healthcare, education, land tenure and taxation systems, as well as proper energy and resource pricing mechanisms, said Jiming Ha, chief economist of China International Capital Corp.
Political reforms are needed to facilitate the economic transition, according to Zhiwu Chen, a Yale professor. The state still controls three quarters of the economy, and Chen suggests Beijing should pool state-owned assets into funds and give its people shares to make them feel richer, enticing them to buy.
It is particularly important to enrich China’s villagers because there are 800 million of them, said Chen. Beijing needs to loosen controls on village land and allow farmers more freedom to transfer their land rights to offer them more wealth.
“China needs to act as aggressively as possible to boost consumption to replace exports,” said Paul Cavey, an economist with Macquarie Bank. “Structural reforms will help China to grow out of this crisis.”
TIME TO FREE THE YUAN
China should draw the right lessons from the credit crunch. If it had moved more decisively on the currency front when the international community was clamouring for reforms, its economy may not have been at so much risk now. But some in Beijing seem to be gloating on the other hand that China may have avoided a bullet by not fully integrating itself with market forces.
Fan Gang, an adviser to the central bank, said recently that if China had bowed to overseas pressure three years ago and sharply re-valued theyuan, the result today would have been a steep drop in the currency and possible balance of payments crisis.
Peking University Professor Michael Pettis, however, asserts that China might have been in much better shape today had it revalued the yuan by 10 percent to 15 percent in 2005, instead of the small one-off 2 percent revaluation it carried out. He argues that China would not have racked up such huge trade surpluses and its growth would have been more balanced.
By focusing on selling the yuan to buy dollars to suppress its currency, China has become hostage to its own monetary policy and created massive liquidity at home which contributed to high inflation earlier this year.
After the revaluation and de-pegging of the yuan, the currency hit a peak in September. As China’s export sector has reeled, Beijing has since allowed the currency to weaken a bit.
But it would be unwise to use currency depreciation to increase China’s ability to export overcapacity because that will almost certainly lead to more trade friction — not a good long-term solution.
Instead, Beijing should view the current storm as a chance to regain its monetary freedom.
No one really knows how the yuan will move if the central bank let it trade freely. Just half a year ago, dealers were saying that the yuan would almost certainly rise in the absence of government interference, but now that the Chinese economy is slowing abruptly and exports have fallen in November for the first time in seven years, traders are less certain.
Still, the Chinese economy remains one of the healthiest in the world, so the yuan would be unlikely to depreciate much. That is why Yu Yongding, a former adviser to the central bank, says it’s time for the government to let go and test the real value of the yuan.
To its credit, China has seized the opportunity to launch at least one major reform. After oil prices tumbled, Beijing agreed to allow limited liberalization of domestic gasoline prices and shifted to a much bigger consumer tax, sending a clear signal that consumers would be required to bear more of the future cost of fuel.
But Pettis said that is merely the unwinding of a bad policy and China needs to work on its core problems.
“There is a difference between moving ahead and not moving backwards,” Pettis said. “Now conditions are difficult but the right reforms are almost always done when things are tough.”
— At the time of publication Wei Gu did not own any direct investments in securities mentioned in this article. She may be an owner indirectly as an investor in a fund. —