By Yu Bin, Department of Macroeconomic Research of Development Research Center (DRC)

Research Report No 013, 2010

In face of the serious impacts from the international financial crisis, the CPC Central Committee and the State Council swiftly introduced an economic stimulus package in 2009. As a result, the Chinese economy made a turnaround after it got stabilized in the second quarter. The growth rate reached 10.7% in the fourth quarter, bringing the annual growth to 8.7%. In 2010, both internal and external environments for economic development will be better than in 2009. In accordance with the basic macroeconomic policy set at the Central Economic Working Conference, the Chinese economy is expected to maintain a steady and fairly development performance based on the continuous turnaround in 2009. But what is worth noticing is that higher price hiking pressure, real estate market adjustment, system constraint to continuous consumption expansion, increased trade friction and growing RMB appreciation pressure will constitute challenges to steady economic growth in 2010.

I. Higher Price Hiking Pressure

The Central Economic Working Conference explicitly noted that China would maintain the continuity and stability of its macroeconomic policy in 2010 and continue to enforce a proactive fiscal policy and a moderately easy monetary policy. This is vitally important to pursuing steady and fairly fast economic development, preventing economic growth from a “double dip”, and ensuring the funding requirement and normal operation of large infrastructure projects launched in 2009. However, in face of an excessively fast rise of assets prices and a growing inflation expectation, how to effectively guard against an assets bubble and keep price hike within the socially acceptable scope is an issue that should receive utmost attention.

There are divergent views on whether there exists inflation pressure in 2010. Some believe that because of widespread industrial overcapacity, continuous bumper harvest of summer and autumn crops, sufficient supply of industrial and farm products and oversupply at current prices, there will be no visible inflation pressure in 2010. However, prices are a monetary phenomenon in the final run. The long-term M1 and M2 fluctuations and the price trends since 1978 indicate that whenever money supply growth enters a stage of expansion, serious inflation would follow and that the longer the expansion continued, the higher the inflation rate would be. During the 1984~1987 and 1991~1995 periods, for example, the M1 and M2 growths all exceeded 25%. Shortly afterwards, hyperinflation, as high as 17%, appeared during the 1988~1989 and 1994~1995 periods. In particular, the CPI went up by as high as 24.1% in 1994. This time, the M2 growth surpassed 25% since March 2009 and reached 27.7% at the end of December. The M1 growth was over 25% as from July and reached over 30% in October and 32.4% at the end of December. Due to the impacts of the constantly fast M1 and M2 growths, the CPI reached the bottom in July 2009 and is expected to continue to rise after becoming positive in November.

In the current market environment, the induction from money supply to price will be different from that in an economy of scarcity. A sharp money supply growth will, first of all, push up the prices of land, minerals and other resource products. Because of excess liquidity and rampant speculation, assets prices will hike and form bubbles as what is happening on the real estate market. Therefore, inflation expectation will continue to rise. In the end, the joint push of rising cost and major comparative income adjustment will drive up the prices of farm and sideline products that are in a delicate supply-demand balance, and in turn will spread to general industrial products.

The international environment indicates that a moderately easy monetary policy and a mass liquidity injection have been main tools to cope with the financial crisis and bring world economy from crisis to rapid recovery. But the price that has been paid is an excess global liquidity, a depreciation of currencies and especially the U.S. dollar, a price hike of bulk commodities on the international market, and a higher global inflation pressure. Since the beginning of 2009, the prices of crude oil, copper, gold and other products have gone up sharply. In 2010, the gradual recovery of world major economies and the higher demand for primary products can further drive up the prices of bulk commodities. In this situation, China will face a growing imported and cost-driven inflation pressure.

To prevent the prices of assets and general goods from rising too fast, it is imperative to control the intensity and timing of macro regulation. One, while the funding requirement should be guaranteed for investment projects already launched, a strict control should be imposed on new projects and the fund schedule and construction scale should be adjusted in step with economic performance whenever necessary. Two, as the credit scale is clearly smaller than in the previous year, funds should be actively directed to the real economy and in particular to the small and medium-sized enterprises, labor-intensive enterprises and the service industry. Three, more subsidies should be offered to increase the income of urban low-income groups and rural residents and to boost their ability to cope with inflation.

II. Real Estate Market Faces Adjustment

Currently, China's personal consumption highlights house and auto purchases. Either in terms of the proportion of real estate investment to total social fixed asset investment, the proportion of housing sales to total social commodity retail and the proportion of real estate added value to GDP, or in terms of the impact of the real estate industry on directly and indirectly related industries, the real estate industry is undoubtedly a pillar industry vital to the national economy. In 2009, investment in real estate development rose 16.1% and housing sales nationwide rose 42.1% to 937.13 million square meters. The rapid growth of real estate investment and sales played an important role in supporting a sustained recovery of the Chinese economy since the second quarter. In 2010, the steady and fairly fast development of the national economy will depend, to a very large extent, on the healthy and steady development of the real estate industry.

As credit has never been so easier and as both housing demand and investment demand have been strong, the real estate market has climbed up further without substantial adjustment, with house prices continuing to rise. In 2009, the average price of residential buildings nationwide was close to 4,700 yuan per square meter, which was 25% or 813 yuan per square meter higher than in 2008. This was the most dramatic hike since the housing system was reformed. In December, the average house price in 70 large and medium-sized cities across the country was up 7.8% year-on-year. In particular, the price hike of new buildings was the highest in five cities: 19.9% in Guangzhou, 14.9% in Jinhua, 14.3% in Shenzhen, 13.4% in Haikou and 13.2% in Beijing. The sustained house price hikes have aggravated social panic and driven up the investment demand. As a result, the supply-demand contradiction has become sharper and the real estate bubble larger. What is noteworthy is that the Asian financial crisis was triggered by the outburst of the real estate and stock market bubbles in some Asian countries and the current financial crisis by the outburst of the bubbles of the real estate and the financial derivatives based on real estate mortgage loans in the United States. The two crises have done intense harms to economies. Once China's real estate bubble is formed, its harms will be equally inestimable.

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