The Chinese economy continued its rapid growth in 2005, while the country's macro-economy operated better than any other year since 1998, according to official Chinese research.

Research conducted by the Academy of Macroeconomic Research under the National Development and Reform Commission shows that as a result of prudent fiscal and monetary policies, the national economy continued to make strides in the planned direction.

While the economy maintained fast growth, an ideal state characterized by no inflation and no deflation prevailed. GDP growth rates in the first three quarters of the year were 9.4 percent, 9.5 percent and 9.4 percent respectively. The rate for the whole year is projected at 9.2 percent.

A year of growth

China's industrial structure has been further optimized as a result of the macro-control policy implemented during the past two years.

Backward production capacity is gradually being shed. A number of calcium carbide, coking and alloy iron plants as well as mini-cement plants not in compliance with the government's industrial policy were shut down.

Greater effort was committed to the merger and restructuring of enterprises, thus bringing about heightened industrial concentration. Weak links in China's economic development were strengthened. Small-scale rural infrastructure development was beefed up. A number of projects were kicked off to develop key techniques in such areas as energy exploration, safe production, energy conservation and comprehensive utilization of resources.

Meanwhile, as investment received by central and west regions continues to slightly exceed that gained by east China, there is a discernible trend toward a more balanced regional economic structure.

The Economic Situation Research Group under the State Information Center found that China's economy made sound headway in 2005, with investment structure improving following a steady decline in fixed asset investment.

Nationwide fixed asset investment is estimated at 8.78 trillion yuan (about $1.09 trillion), representing a year-on-year increase of 25.3 percent, a decline of 0.5 percentage point from last year. More investment was pumped into agriculture, while the growth rate of investment in the manufacturing sector slowed and that in tertiary industry kept relatively stable.

In the first eight months of 2005, investment in primary industry reached 39.6 billion yuan ($4.9 billion), an increase of 20 percent over the same period last year, up 3.7 percentage points from the growth rate a year ago. Investment in secondary industry was 1.73 trillion yuan ($214.4 billion), growing 35.2 percent from the same period last year, down 6.5 percentage points from the growth rate a year ago.

Investment in weak sectors such as coal, electricity, oil and transportation has risen dramatically, whereas the growth rate of investment in overheated industries such as iron and steel and alloy iron has plunged.

The situation in which the growth of heavy industry outpaced that of light industry is being reversed. From January to August, the growth rate of heavy industry was 16.9 percent, 1.7 percentage points lower than last year's 18.6 percent. The gap between the growth of heavy industry and that of light industry narrowed from 3.2 percentage points last year to 0.7 percentage point.

The narrowing gap indicates that the economy has begun to develop in a more balanced and stable way. Thanks to the lowered growth rate of heavy industry, pressure on transportation and electricity sectors, long-time bottlenecks for China's economic development, was lessened to some extent.

The persistent low consumption demand began to pick up. Consumption played an increasingly important role in promoting economic growth. In the first three quarters of 2005, total retail sales of consumer commodities reached 4.508 trillion yuan ($557.6 billion), up 13 percent year on year, hitting a record high since 1997. The figure accounted for 42.4 percent of China's GDP, up 1.3 percent from the same period last year.

As the income of farmers kept rising, the consumption growth disparity between rural and urban areas narrowed slightly. In the first half of 2005, farmers' per-capita cash income reached 1,586 yuan ($192), an increase of 12.5 percent in real terms. The growth rate was 1.6 percentage points higher than that of last year. The growth rate of farmers' per-capita net income for the whole year is projected at over 5 percent in real terms.

In 2005, both rural and urban markets turned out brisk, a rarity for quite a few years. In the first eight months, retail sales in urban and rural markets grew by 14 percent and 11 percent respectively. The gap between growth rates declined to 3 percentage points from 5.1 percentage points last year.

The financial market was further opened up. Foreign financial institutions were given the green light to conduct RMB business in China. The yuan was revaluated by a small margin, giving shape to a more flexible exchange rate system. The reform of state-owned banks was accelerated, with China Construction Bank's listing in the Hong Kong Stock Exchange.

However, the Chinese economy in 2005 was not trouble-free.

First, there was a notable increase in international trade frictions. Trading partners imposed a series of barriers on a variety of Chinese exports, worsening China's external trading climate. Despite these hindrances, China's foreign trade volume is expected to hit $1.4 trillion for the whole year. The growth rate of exports tends to be much faster than that of imports, with the former expected to reach 29 percent, while the latter 19 percent. The trade surplus is projected at $100 billion this year. Initial calculations indicate that net export will contribute more than 35 percent to China's economic growth. Foreign demand played an abnormally big role in stimulating economic growth. State Information Center researchers pointed out that the chronic foreign trade surplus and excessive role of foreign demand in fueling the economy underscore potential economic fluctuations.

Second, the energy problem was still a pressing concern. China suffered a transient oil scarcity when oil prices skyrocketed in 2005, impacting sustainable and balanced economic development.

In addition, the inertia effect of the investment-driven economy was evident. There was an increase in the number of overproducing industries. Apart from cement, electrolytical aluminum and some other already overheated industries, iron and steel, auto, flat glass and chemical fiber industries are also facing the risk.

Future plans

In 2006, China will proceed with prudent fiscal and monetary policies so as to direct its economy along the path of stable and rapid development, according to the Central Working Conference on Economy that concluded on December 1 in Beijing. The annual conference set guidelines and major tasks for the Chinese economy in 2006.

On December 11, the Chinese Academy of Social Sciences (CASS) released a blue paper on China's economy, saying that GDP growth rate in 2006 will be around 8.8 percent, a goal the Chinese Government has pursued for the past two years. Wang Tongsan, Director of the Institute of Quantitative and Technical Economics under the CASS who was responsible for drafting the document, said that as China's macroeconomic operation is in a period of stable growth, next year's macroeconomic control should focus on maintaining the stability and continuity of economic policies.

Analyzing from the perspectives of investment, consumption and import and export--three locomotives driving the national economy--State Information Center researchers reached a number of conclusions on China's economic landscape in 2006.

Less fixed asset investment

According to the researchers, many new projects were initiated in 2005, pointing to a potential growth in fixed asset investment. In addition, 2006 is the first year of China's 11th Five-Year Guideline, when a number of major infrastructure projects will be kicked off. Given these factors, fixed asset investment is likely to maintain a rapid growth.

Nevertheless, the government is expected to take tough macro-control measures to rein in the trend. After land requisitioned in the past few years is used up, a limited land supply resulting from the government's stringent land control policies will hold back fixed asset investment in the upcoming year.

Moreover, the growth rate of the banks' long- and medium-term loans began to decline this year, something that is likely to affect the growth of fixed asset investment next year, especially in the real estate sector.

Overproduction in the manufacturing sector will become more prominent in 2006. Rising production costs and declining prices will further erode the profit margin for some businesses, thus dampening their enthusiasm about investment and expansion.

Meanwhile, confronting escalating international trade frictions and mounting pressure from their overproducing Chinese counterparts, foreign companies in certain sectors tend to slacken their efforts to shift production to China. In the first eight months of this year, paid-in foreign investment dropped by 3.02 percent from the same period last year.

The rare decline is expected to constrain foreign capital inflows in certain industries next year. In light of this, fixed asset investment growth is expected to drop steadily in 2006. The growth rate is estimated to drop by 5 percentage points compared with 2005 to stand at about 20 percent.

Blooming consumption market

Several advantageous factors will contribute to rapid consumption growth in 2006.

First, as farmers' incomes have been on the rise for two successive years, the rural consumption structure is being steadily upgraded. Rural residents in China's vast hinterlands are becoming consumers of big home appliances on the heels of their better-off peers in the east coastal region.

Second, the average income of urban residents continues to rise. Middle-income earners have become a main driving force of the urban consumption market. Some local governments raised minimum salaries and unemployment benefits in 2005. The monthly personal income tax threshold was raised from 800 yuan (nearly $100) to 1,600 yuan ($200). Many local governments are expected to adopt policies that favor low- and middle-income earners. Civil servants could earn more money, a trend that would likely lead to salary increases for all urban employees. These moves will help nurture more middle-income earners, while tapping their consumption potential.

Third, the constant improvement of the social security system is conducive to the expansion of immediate consumption. As the social security system improves with more funds allocated by the government, residents will become more confident about the future. They may abandon the habit of saving money in the bank, letting loose the urge to consume.

More balanced international trade

Researchers predict that while the world economy will stay in good shape in 2006 with accelerating international trade growth, China's export structure will be upgraded, with exports becoming more competitive in the international market.

As the country's production capacity keeps growing, escalating domestic competition will force more companies to venture into the international market.

At the same time, imports are projected to increase considerably, given the energy shortage and the lack of raw materials, advanced technology and key equipment. The growth rate of exports and imports is estimated at around 15 percent and 17 percent respectively.

Flip side

State Information Center researchers note that there will be quite a few unfavorable factors affecting China's economic growth in 2006.

Under the impact of high oil prices, the Chinese economy will face increased pressure to develop. In addition, possible fluctuations of the RMB under the newly adjusted exchange rate mechanism will affect China's international trade next year.

Other negative factors include the insufficient supply of coal, electricity, oil and transportation facilities, ever-rising capital goods prices in domestic and international markets, environmental protection pressure, increasing trade frictions and the international community's opposition to the highly energy-consuming products made in China.

Lu Jianhua, an official with the Ministry of Commerce, said China's foreign trade may face a more critical situation in 2006 than in 2005, adding there is no reason whatsoever to be blindly optimistic about export growth.

Owing to its limited shares in the international market and trade protectionism worldwide, China will find it difficult to maintain its fast export growth, which has lasted for the past four years. China's foreign trade volume will hopefully exceed $1.6 trillion, up 15 percent, Lu said. However, the growth rate will be notably lower than that in 2005.

According to the Academy of Macroeconomic Research of the National Development and Reform Commission, China will have to confront growing deflation pressure next year. With export and investment slowing down and production capacity soaring, the Chinese economy will undergo even greater adjustments in 2006. Imports will grow more rapidly than exports, a trend that could halt the growth of trade surplus, if not necessarily erase it.

Since September, there has been a considerable decline in the price growth rates in the Chinese market. In particular, the general price index for capital goods dropped 0.2 percent compared with the same period last year. This could be interpreted as the earliest sign of deflation.

In terms of money supply, M1 and loans are only growing at a slow pace, not enough to fuel a price rebound. With deposits increasingly outnumbering loans, there is an evident tendency toward financial contraction. All these could point to a slight deflation in 2006.

(Beijing Review January 5, 2006)