The World Bank quarterly update provides an update on recent economic and social developments and policies in China, and present findings from ongoing World Bank work on China. The update is produced by a team from the Beijing Office with support from the China country team.

Overview

The impact of the international financial and economic turmoil on China's economy has been manageable so far, but is expected to intensify. China's financial system is relatively insulated from the direct impact of the international financial distress. In the real economy, overall export growth has until recently remained robust due to strong demand from emerging markets and gains in global market share reflecting strong competitiveness, although with pronounced differences in export performance between sectors. However, looking forward, the impact of the crisis is spreading globally, with risk aversion and deleveraging leading to a funding squeeze that affects demand in many countries, including many emerging markets. Thus, as in earlier global downturns, China's export growth is likely to be low in 2009, even with expected continued market share gains.

Domestic factors have already made China's economy slow down in 2008, coming off its high pace in 2007. Due in part to an earlier tightening in macroeconomic policies, investment growth declined in 2008, led by real estate and construction, which then fed through to several "upstream" industries. Most other segments of the domestic economy, notably consumption, seem to have held up reasonably well so far. Looking ahead, private sector investment is likely to be weighed down by the unfavorable external prospects and continued weakness in real estate. Private consumption growth is likely to soften in 2009, but will receive some support from fiscal policy. In the mean time, inflation is coming down steadily. After absorbing higher food prices, headline inflation has receded and, with sharply lower raw commodity prices, inflation is not an issue of concern at this point.

Against this background, the authorities have adopted a more expansionary macroeconomic stance, and higher government-influenced spending is going to play a key role in 2009. Since the summer of 2008, the authorities have taken several steps to support growth, culminating in November with a 10-point plan to stimulate domestic demand and growth. The emphasis will be on accelerating and increasing infrastructure and other investment, although of a different nature than in the wake of the Asian crisis, with many projects focusing on broad long-term development and improving living standards. Most of the 10 elements mean higher direct government-influenced spending—in the form of investment or consumption—and should thus have a measurable impact on output in the short term. Our forecast for 2009, which sees GDP growth of around 7.5 percent based on current projections of global economic trends, has more than half of that coming from government-influenced spending.

The stimulus policies provide China with a good opportunity to rebalance its economy in line with the objectives of the 11th Five-Year Plan. The stimulus package contains many elements that support China's overall long-term development and improve people's living standards. Some of the stimulus measures give some support to the rebalancing of the pattern of growth from investment, exports, and industry to consumption and services. The government can use the opportunity of the fiscal stimulus package to take more rebalancing measures, including on energy and resource pricing; health, education, and the social safety net; financial sector reform; and institutional reforms.

Recent Economic Developments

China's economy has slowed down considerably in the first 10 months of 2008. GDP growth declined from 12.6 percent year on year in the second quarter of 2007 to 9 percent in the third quarter of 2008, with industrial value-added growth sliding even more steeply in October to 8.2 percent year on year, the first single digit growth since 2001 (Figure 1). Much of the slowdown so far has come from weaker domestic demand.

Over the past year, the impact of the international financial turmoil on China's economy has been manageable. Since mid-September this turmoil intensified and evolved into a global financial crisis. Deleveraging and rising risk aversion is causing capital flows to many emerging markets to slow and in some cases to reverse, which hurts currencies, interest rates, stock markets, trade financing, and the real economy. The direct impact of the financial turmoil on China's financial system has been limited, however, because China's banks have modest exposure to subprime assets and the authorities impose capital controls, while the accumulation of large external surpluses mean that the financial system enjoys abundant liquidity and the central bank massive foreign reserves. China's real economy is integrated into the world economy via extensive trade and foreign direct investment (FDI) links, and can thus not escape the global downturn. However, so far exports have held up relatively well, growing at 13 percent year on year in real terms since mid-2008, compared to world import growth of almost 6 percent estimated for 2008 (Figure 2). This is because demand from Europe and, particularly, emerging markets held up well until recently, and China continues to gain market share reflecting strong competitiveness.