With fewer people skeptical about overheating in the economy, or to be specific, over-investment, the focus has shifted to the government's role in reining in the trend.

Its capacity to anchor the economy and ensure a soft landing will direct the next-stage economic development track.

"Debate is now weakening as to whether the economy is overheated," said Fan Gang, director of the National Economic Research Institute.

"Last June when the SARS (severe acute respiratory syndrome) crisis had just come to an end, people were sharply divided when we warned against an overheated economy being pushed by increasing investment," he said at the recent China Economic Forum co-sponsored by the British Embassy in China and Beijing Normal University.

Fixed asset investment increased by 28, 29, 31 and 32 percent year on year respectively in the four quarters last year.

The continued momentum - 47 percent in the first quarter this year - fuels some people's worry that the economy may encounter a disastrous hard landing this year.

This time, however, the government has adopted "timely and effective" measures, which will contribute to a soft landing, according to Fan.

The latest statistics augur well for Fan's argument. In April, fixed asset investment slowed down to register a year-on-year 34.7 percent growth, 8.8 percentage points lower than in March. The average level through the first four months is 42 percent.

But challenges remain.

In retrospect, the central authorities have adopted a raft of policies - both monetary and administrative - to cool down the excessive heat of the economy since last year.

People's Bank of China, the central bank, raised its reserve requirements three times. In the latest move, it announced on April 11 it was raising the minimum amount of deposits required to be held as reserves from 7 percent to 7.5 percent.

The move followed the bank's March 24 policy adjustment of raising some loan interest rates for commercial banks and lifting the reserve ratio for banks with lower-than-average capital adequacy ratios.

Other recent moves to rein in runaway investment growth include tighter restrictions on new projects in "over-invested" industries such as real estate, cement and steel and ordering banks to be more conservative in lending money.

All this seems to have had a bearing on the market.

Real estate investment has seen significant slow down and the prices of steel and aluminum, two culprits of the soaring investment, have decreased, according to the National Bureau of Statistics.

The central bank statistics show that by the end of April the total loan outstanding of all financial institutions, including foreign ones, was 18.12 trillion yuan (US$2.18 trillion), up 20.4 percent year on year, which is roughly the same pace as in March. The renminbi loan outstanding increased by 19.9 percent year on year, 0.2 percentage points lower than in March.

"The government has reacted more quickly than it did in the 1993-94 period," said Fan.

Back then, the soaring economy produced a lot of bubbles, which contributed to the later deflationary cycle that severely damages the national economy.

If economic growth can be put around 9 percent, it will be good news for the country as well as its neighboring countries, which will not suffer an abrupt downturn in their China-oriented exports, said Fan.

The worst scenario would be that the economy grows by more than 10 percent, which will risk ushering in a new round of deflation in 2005, he warned.

Fan's warning is not groundless.

In terms of investment, fixed asset investment remains at a high level. The credit increase is also high, although it has displayed a flickering sign of slowing down.

More alarming is the consumer price index (CPI), the policy makers' major gauge of inflation, which increased by 3.8 percent in April year on year from the 2.8 percent growth in the first quarter. It was the highest in the past seven years.

In March, the corporate goods price index increased 8.3 percent, which has kept rising in the past 16 consecutive months, according to the central bank.

"This year, the CPI may finally reach 6-7 percent, but China will not witness high-rate inflation," said Fan. "What we should caution against is a new round of deflation, which would be more dramatic (if we cannot contain the overheating of the economy)."

Last week, Zhou Xiaochuan, central bank governor, was quoted by the China Economic Times as saying "we are still watching the situation as long as the CPI is kept below (the benchmark security line of) 5 percent."

This means the authorities would not consider raising the interest rate right now. On the other hand, it leaves room for future maneuvers if the CPI continues to rise as Fan predicted.

Given China's real situation, however, raising the interest rate may not be an advisable move at the current stage.

China's interest rate formation and transmission mechanism has not yet become market-oriented. Even if the rate is adjusted, the market may not react so responsively as it does in a mature market like the United States, said Li Yang, director of the Institute of Finance under the Chinese Academy of Social Sciences.

In the current round of over-investment, ardent local governments have played a leading role in many large-scale projects. They set their eyes on short-term benefits and coax or coerce local commercial bank branches into providing finance.

They are roughly non-sensitive to interest rate adjustment.

So administrative measures may be a choice, although they risk incurring low efficiency and rent-seeking as the State imposes industrial controls.

The authorities have kept a firm hand on unauthorized construction of new projects.

The State Council recently sent a special group to investigate the construction of a 10.6 billion yuan (US$1.27 billion) iron project in the cities of Changzhou and Yangzhong in East China's Jiangsu Province, which demonstrates its determination to corral the black sheep.

Admittedly, such administrative measures have contributed to the halting momentum of some hot industries.

Such non-market policies, however, should only serve as interim efforts to cool down the economy. In the long run, interest rate liberalization should be the right cure.

(China Daily May 28, 2004)