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UPDATED: September 30, 2011 NO. 40 OCTOBER 6, 2011
Rebalancing Challenges

GREEN FUTURE: A wind power plant in north Inner Mongolia Autonomous Region. Economists believe a key part of China's economic rebalancing lies with developing green technologies and heightening energy efficiency (ZHANG LING)

China's economic rebalancing is in the global spotlight because it has far-reaching implications for both China and the world. What triggered the imbalance? How should China push forward the adjustment? Economists and researchers discussed these questions at the Conference on Changing Global Economy and China's Macroeconomic Development organized by China & World Economy, a bimonthly English journal published by the Institute of World Economics and Politics of the Chinese Academy of Social Sciences on September 22 in Beijing. Beijing Review reporter Hu Yue attended the conference. Edited excerpts of some participants' views follow:

Cause of the imbalance

Yu Yongding, a renowned economist and academician of the Chinese Academy of Social Sciences

The Chinese economy is facing a striking imbalance from "twin surpluses," namely current account and capital account surpluses. The country has taken steps to redress the imbalance, but progress has been painfully slow, and the economy is sinking into a "dollar trap." China has accumulated $3.1 trillion of foreign exchange reserves, mostly parked in U.S. Treasury securities with low returns. Worse still, the value of those assets is shrinking due to the devaluation of the U.S. dollar.

The reasons for the twin surpluses are complicated. The government promoted exports due to a shortage of forex reserves in the 1980s. Favorable treatment to export companies and heavy tax rebates, as well as undervaluation of the yuan encouraged exports and led to a current account surplus.

Meanwhile, the capital account surplus ballooned due to torrential inflows of foreign direct investment (FDI). Owing to the underdevelopment of the financial markets, it was difficult for many Chinese enterprises to raise funds, so they tried to attract FDI. Foreign investors also favored China thanks to its generous policy incentives, cheap labor and land, as well as lax environmental regulation.

In addition, China allowed foreign investors to acquire equities of Chinese firms and encouraged introduction of foreign strategic investors when it restructured big commercial banks a few years ago. Consequently, foreign capital poured in and added to the country's forex reserves.

In recent years, the Chinese Government has spared no effort to correct the imbalances by stimulating domestic consumption, encouraging outbound investments and internationalizing the renminbi. But maybe it is time for China to consider allowing the yuan to float freely, while reserving the right to intervene with cross-border capital flows in case of emergencies.

Slick prospect

Louis Kuijs, chief economist, Asia, MF Global

Despite external headwinds, China's macroeconomic outlook remains relatively favorable. Economic growth is moderating because of the global slowdown and domestic monetary tightening. But growth drivers remain intact, including urbanization, investment and a surge in productivity.

Meanwhile, inflation is likely to have peaked. With food price shocks fading out and softer industrial raw material prices, headline inflation should come down gradually in the coming six months. Policymakers may ease their monetary stance, but less dramatically than in late 2008.

Continued European sovereign debt woes and a lack of medium-term fiscal credibility in the United States and Japan impact the Chinese economy mainly via weakened exports—less so via financial channels.

The Chinese Government intends to put a lot of attention on addressing macroeconomic problems. But in my view, the country's real policy challenges are the structural ones. They will not be resolved without a substantial policy.

Rebalancing the growth pattern toward more services and consumption requires an array of policies. Some argue that the tightening of the labor market and the ensuing wage increases will largely take care of the rebalancing. However, that is not enough. A set of policies is needed to undo the factors that have amplified China's investment-driven growth model.

One set comprises reforms to channel more resources into areas that support sustainable growth, such as improving access to finance for the private sector and service-oriented and smaller firms. The country also should press ahead with scaling up of the state-owned enterprise (SOE) dividend policy to improve the allocation of capital. Efforts are also required to remove restrictions on service sector development and open up more service industries to private investors.

Another important step is to promote reforms to boost urbanization, including further liberalization of the household registration system and land reform.

Financial reforms should include liberalizing the renminbi exchange rate, opening up the capital account and introducing more market-based monetary policies. However, the key is to proceed in the right sequence in order to avoid financial turmoil.

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