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      Timetable for reform

      2014-03-24 13:56 China Daily Web Editor: qindexing
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      China has to restructure its economy in a way that growth doesn't dip

      How long does China have to change its economic model before it runs into trouble?

      In a new book, Michael Pettis, professor of finance at Guanghua School of Management at Peking University, says it has three years at the outside.

      He argues that the return on investment in infrastructure and other projects is no longer covering the cost of finance and just adding to China's debt burden, which could result in economic growth suddenly collapsing.

      Economic reform is certainly uppermost on the Chinese government's agenda.

      At both the Party's Third Plenum at the end of last year and at this month's National People's Congress and the Chinese People's Political Consultative Conference, policies were laid out that, if successfully implemented, would rebalance the economy from investment toward consumption.

      These included such measures as interest rate liberalization, which could redistribute capital from the state to the private sector, tackling the over-dominance of state-owned enterprises in the economy and reform of the hukou, or household registration system, allowing workers and their families to have access to higher-paid jobs in cities.

      To what extent the Chinese economy is under the sort of strains that Pettis outlines in Avoiding the Fall: China's Economic Restructuring, which the Financial Times selected as one of the most important economics books of the past 12 months, remains to be seen.

      Certainly debt is an issue with local government debt alone soaring 70 percent during the past three years to $17.9 trillion yuan ($2.9 trillion; 2.1 trillion euros), according to official figures.

      Some such as Charlene Chu, formerly senior director of ratings agency Fitch & Co, have warned that China's 4 trillion yuan stimulus package in the wake of the financial crisis could cause serious problems for China's banking sector.

      She argues that the increased bank lending in China since 2009 of around $15 trillion is equivalent to the entire size of the US commercial banking sector.

      According to Pettis, it is over-investment that is causing the debt to pile up at such a rapid rate.

      Some 49 percent of China's GDP was made up of investment, compared to 19 percent in the US, 15 percent in the UK, 17 percent in Germany and 20 percent in France, according to World Bank statistics published last year.

      China's consumption, however, was languishing at 36 percent, compared to 65 to 70 percent in the US and many European countries.

      Is the China economic model as fragile as Pettis and others make out? What is wrong with an economy that by most estimates has two more decades of fast development left?

      Martin Wolf, chief economics commentator at the Financial Times who has been following the Chinese economy for more than 20 years, says it would be possible to make the assumption the economy could be heading for a crash.

      "This is an extraordinary unbalanced economy and showing signs of getting worse. If you were looking at any other economy you would say that there could well be a financial crisis and then afterwards a substantial diminution of economic growth rates."

      He says that such a judgment, however, would be ignoring China's track record of the past 35 years and the control the government retains over the economy.

      "The Chinese government effectively controls all the levers in the economy and it can use them in a way that almost no other country has been able to do. The government in itself is also enormously solvent. A third factor is that China is still a relatively poor country and in principle still has good growth potential as catch-up continues."

      Wolf believes the government still needs to engineer an adjustment where investment falls to around 35 percent of GDP but this does not have to lead to a collapse in growth.

      "I am perhaps more optimistic than Michael (Pettis) that the government could take actions to cushion the adjustment but I think it would be a mistake for them to prevent it."

      Some high profile Chinese economists see no problem with China's investment-fueled growth model.

      Liu Zhiqin, senior fellow at the Chongyang Institute for Financial Services at Renmin University of China, says the country needs a high level of investment because it is still a developing nation. "For a developing country investment is the main driving force for the economy and consumption is something additional.

      "The real problem in the global economy might not be China investing too much but Western countries consuming too much. Americans are always inviting Chinese investment and European politicians are always coming to China looking for investment since they can do nothing but promote consumption at home."

      Liu also believes that China's debt problem is often exaggerated with some estimating it at 240 percent of GDP when the National Audit Office data calculates it at just 58 percent.

      "What some count in their figures is money the Ministry of Finance supplies to the market in order to enhance liquidity. This is good for the market. It is like China's QE (quantitative easing)," he says.

      "It is not debt because most of the money that has been lent out this way to local governments and SOEs (state-owned enterprises) could be paid back."

      George Magnus, senior independent economic adviser for UBS in London, takes major issue with such an argument and does think China's debt burden is a major problem. He also agrees with Pettis that an investment bust could occur within three years.

      "I'd say 'within three years' is about right. The key preconditions are already in place: high levels of debt and credit intensity, slowing growth, and a rising incidence of financial stress and debt service capacity problems," he says.

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