How China can ensure stable 2022 growth


The November inflation rate in the United States soared 6.8 percent year-over-year, which is the highest since November 1990. Federal Reserve Chairman Jerome Powell hinted about inflation in early December by telling US lawmakers that it is probably a good time to retire the word "transitory "when describing inflation. The US government's intention to contain inflation has been quite clear.

Starting from November 2021, the Fed began a new round of tapering by reducing purchases of bonds and mortgage-backed securities. But US monetary policy is undoubtedly quite loose.

Therefore, a moderate inflation rate is important. Most developed countries set the target at 2 percent, and for developing countries, inflation rates between 3 percent and 5 percent may be more comfortable. The key is to bring inflation under control, preventing spiraling price and income increases

To understand US inflation, one should find primary causes. Scholars and officials from the Fed and other government departments find supply chain disruptions responsible. Overseas suppliers cannot provide goods as usual. The US is also confronted with labor shortages due to COVID-19 disruptions to workplace and work habits.

Therefore, it is highly probable that the US will exit quantitative easing in June and elevate interest rates next year, which will impact the Chinese economy to some extent. The widening interest rate gap between China and the US will result in capital inflows into the US, which will pressure the renminbi to depreciate.

If the renminbi does not depreciate, it is necessary for the Chinese government to intervene in the foreign exchange market. Foreign exchange reserves may thus decrease and the monetary base may be influenced as a result. If the renminbi depreciates, trade frictions may intensify and import prices may go up, which will exert greater inflationary pressure in China.

All in all, tightening monetary policies in the US may result in many constraints which may refrain China from adopting relaxed monetary policies.

The tightness of monetary policies should be decided by three major factors: GDP growth rate, inflation forecast and the fragility of a country's economy.

First of all, China's GDP growth rate for 2021 will undoubtedly exceed 6 percent. But it should be noted that this number is largely due to the lower base of 2020.

Second, there is indeed strong upward momentum seen in China's inflation figures, as the consumer price index has already come in at 2.3 percent in November. But for a developing country like China, that reading is still quite low. Consumers will definitely hope for cheaper prices, which does not hold true for companies. Therefore, a moderate inflation rate is important. Most developed countries set the target at 2 percent, and for developing countries, inflation rates between 3 percent and 5 percent may be more comfortable. The key is to bring inflation under control, preventing spiraling price and income increases.

Although China's CPI reported year-on-year increases in November, it has contracted from a month earlier. While the producer price index has still expanded significantly, it has declined both on a monthly and a yearly basis. The PPI's higher volatility should also be noted. Over the past decade, China's PPI has reported declines for seven years. Even measured against a fixed base, the latest PPI readings have not exceeded the peak seen 10 years ago.

In this sense, inflation has not become the most important reference for monetary policy.

The fragility of the Chinese financial system is another big concern. Leverage ratios are the most frequently used indicators to measure an economy's financial fragility. In terms of the overall leverage ratio, China's situation is similar to that of the US and Europe, and much lower than that of Japan.

The prominent issue in China is the high leverage ratio of companies. But there is no such thing as a globally adaptable critical value of such a ratio for companies. Chinese enterprises' high leverage ratios can be largely attributed to their blind expansion, and sometimes related to overly loose monetary policies. But companies' leverage ratios started to decline in 2016 and are not serious enough to shake the country's financial stability.

Generally, high leverage ratios are a product of high rates of savings in China. Given the country's smaller foreign debt and systemic advantages, it has a higher tolerance for high leverage ratios than Western economies.

Therefore, the major issue that China has to address at present is insufficient demand and lackluster economic growth.

China's GDP growth has remained at around 10 percent on average for four decades. But this does not necessarily mean that the number will be halved over the next 10 years. The growth target should be based on past experiences and the trial-and-error methodology. If inflation is under control and the financial system is stronger than expected, expansionary fiscal and monetary policies can be adopted to stimulate economic growth.

China started to discuss normalization of policies as early as 2010 by exiting expansionary fiscal and monetary policies prematurely. But the fact is, China has not returned to the "normal" track at present. There is still residual impact from the 2008 global financial crisis, let alone the impact of the COVID-19 pandemic on the world's economy.

While cities were locked down during the pandemic, the supply side was the major victim. Expansionary fiscal and monetary policies would have made little difference to consumption and investment. But as the contagion is contained, the problem of insufficient demand has emerged again, which calls for expansionary fiscal and monetary policies.

China's central bank announced on Dec 15 the lowering of the reserve requirement ratio, which is completely correct. The central bank's emphasis on prudent monetary policy has not changed. The RRR cut is just a regular operation so that part of the capital can be released to financial institutions to return medium-term loan facilities. Small and medium-sized enterprises will also be better supported with more liquidity in the system.

The recent RRR cut will have a strong positive effect on the current Chinese economy. But more effective policies such as lowering the benchmark interest rate should be implemented to boost economic growth.

Consumption has not rebounded significantly after the contagion has been largely contained in China, which is a phenomenon totally within expectations. Given the lack of an endogenous growth engine, expansionary fiscal and monetary policies should be adopted to support infrastructure investment. This may sound cliched, but infrastructure investment will result in investment in public utilities, medicine, public health and research and development at this time.

By creating a virtuous cycle between infrastructure investment and investment in other sectors, a virtuous cycle will be formed between investment and consumption. In this way, China will be able to attain stable economic growth and reduce its reliance on external demand.

The writer is a former president of the China Society of World Economics and director of the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. He also served on the Monetary Policy Committee of the People's Bank of China between 2004 and 2006.

The views don't necessarily represent those of China Daily.