Dr. Fan Gang, director of the National Economic Research Institute, China, visited Japan in mid-December on the publication of the Japanese version of his book China's Unfinished Economic Reforms by Iwanami Shoten Publishers (note). In his presentation titled "The New Boom and the Potential Problems of the Chinese Economy" held at the Research Institute of Economy, Trade and Industry on Dec. 18, he focused on the issue of economic overheating in China, which is also a matter of keen interest in Japan. Dr. Fan had pointed to the need to be on the watch for an overheating of the Chinese economy as early as mid-2003, when the SARS outbreak subsided ("Is the Economy Overheating?" International Finance News, July 31, 2003). Since then, overheating has turned from simply being a risk into a reality, with the Chinese economy growing by 9.1% in the third quarter and the consumer price index rising 3% in November on a year-on-year basis.
The force fueling the economic expansion that is serving as the backdrop for the current overheating is investment. The new economic policies and personnel reshuffles at various levels of leadership that accompanied the National Congress of the Communist Party of China held in autumn 2002 have led to an expansion of public works projects, while the rise in foreign direct investment since China's entry into the World Trade Organization is pushing up private capital investment. In addition, the acceleration of urbanization and the spread of home loans are spurring a rise in housing investment. Meanwhile, on the funding side, the four major state-owned commercial banks are striving to increase lending - the denominator in the non-performing loan ratio - so as to whittle down their ratios ahead of plans to go public, and the credit crunch that had been restricting investment is abating. As a result, fixed investment during the January-October period surged 30 percentage points year-on-year, surpassing the previous boom triggered by Deng Xiaoping's speech made during his 1992 tour of Southern China.
As for his future outlook for the Chinese economy, Dr. Fan presented two scenarios, a soft landing and a hard landing, based on the recognition that current growth levels of 8 to 9% more or less match China's potential. In the soft landing scenario, growth in investment will gradually slow down due to a shift from the current fiscal expansion policy and a further tightening of monetary policy that began last summer, thereby keeping growth at its potential level. As a result, the rise in the inflation rate will remain mild and stable growth will continue into 2005. In contrast, in the hard landing scenario, economic growth in 2004 will greatly exceed China's potential level due to insufficient tightening of monetary and fiscal policy, but in 2005 demand will not be able to keep up with supply, leading to excess capacity. As a result, the virtuous circle of investment expansion and accelerated growth that we have seen so far will be replaced by a vicious circle of slackening investment and decelerating growth, and the Chinese economy will again find itself in a deflationary phase.
Dr. Fan gives high marks to the Chinese authorities' cautious policy management and makes the soft landing scenario his main one. There is no doubt that the continued high growth of the Chinese economy in 2004 is good news for the many Japanese companies that are boosting sales and profits through expanding exports to China. However, on the other hand, we need to be vigilant of the sustainability of China's economic growth as well as the risk that inflation may accelerate. As in the case of the yuan's appreciation, a rise in prices in China will lead to an increase in the international competitiveness of some Japanese firms that compete with China, but for the many Japanese companies that are outsourcing to China this would push up costs and effectively cut into profits. Ironically, China-induced inflation is not something that Japan, which had been so critical of China-induced deflation, can unreservedly be happy about.
