CHINA ECONOMY IN 2009: EIGHT PERCENT GDP GROWTH

C O N F I D E N T I A L SECTION 01 OF 03 BEIJING 004665

SIPDIS

STATE FOR E, EAP, EAP/CM
TREASURY FOR OASIA/DOHNER/WINSHIP
TREASURY FOR IMFP/SOBEL
NSC FOR LOI

E.O. 12958: DECL: 12/24/2028
TAGS: ECON EFIN ETRD CH
SUBJECT: CHINA ECONOMY IN 2009: EIGHT PERCENT GDP GROWTH
ACHIEVABLE; CORRECT POLICIES, GOOD LUCK NEEDED

Classified By: Acting Economic Minister Counselor Robert Forden; Reason
s 1.4 (b, d)


1. (C) Summary: World Bank, IMF, and ADB representatives in
Beijing largely agree that China's economic performance will
be very weak through at least the first quarter of 2009.
While still forecasting 7.5-8.5 percent growth for all of
2009, all three concur that there are "big risks on the
downside" if there are any more "surprises" in the United
States, China, or the world. They also share concerns about
the composition and implementation of the government's RMB
four trillion (USD 584 billion) fiscal stimulus package. The
World Bank says China now needs a new growth model, with
greater reliance on domestic consumption rather than exports,
because the world economic environment has changed
permanently. China also will need to improve social programs
to assist growing numbers of unemployed people. While senior
leaders reportedly have reacted positively to these
recommendations, the Bank fears provincial and local
officials might not share this "good vision." Chief
economist Ha Jiming of the China International Capital
Corporation (CICC),who previously worked at the IMF, offered
a considerably more pessimistic prognosis for China's
economy. He said the challenges China now faces are far
greater than those during the Asian financial crisis of the
late-1990s, while its ability to recover might be reduced.
He expects 2009 GDP growth to fall below the eight percent
target, with negative export growth as well as deflation.
Furthermore, Ha said China will not be able to "bottom out"
in 2009 unless additional government policies are
implemented. End Summary.


2. (SBU) On December 19, Assistant Minister of Finance Zhu
Guangyao hosted an informal discussion of the ongoing global
economic and financial crisis, as well as China's economic
prospects for 2009 and beyond. Participants included World
Bank Country Director David Dollar, IMF Senior Resident
Representative Vivek Arora, Asian Development Bank economist
Yolanda Fernandez Lommen, U.K. Embassy Counselor Duncan
Sparkes, Japan Embassy Counselor Shibata Satoru, and China
International Capital Corporation (CICC) Chief Economist Ha
Jiming.

IMF: Big Risks on the Downside
--------------

3. (C) The IMF expects China's economic performance to be
"very weak" for the fourth quarter of this year and the first
quarter of next year, possibly extending into the second
quarter of 2009. According to Arora, China's economic
slowdown, which started earlier this year with the property
sector, now has broadened; imports, the Purchasing Managers'
Index (PMI),and the Consumer Price Index (CPI) all are
declining. While still forecasting 8.5 percent growth for
all of 2009, the Fund agrees with the Bank that there are
"big risks on the downside" if there are any more "surprises"
in the United States, China, or the world. One point in
China's favor is that the government responded to the crisis
at a very early stage with its stimulus package, monetary
easing, and some social service reforms. Now, the IMF's main
concern is the composition and implementation of the RMB four
trillion (USD 584 billion) fiscal stimulus package; in the
medium term, greater focus on consumption rather than
productive capacity would be in China's interest. Also, the
"imbalances problem" has not gone away.

World Bank: New Growth Model Needed
--------------

4. (C) According to the World Bank, China needs a new growth
model because the world economic environment has changed
permanently. It will be difficult, but not impossible, for
China to meet the Bank's forecast of 7.5 percent GDP growth
in 2009; both good policies and good luck will be needed to
do so. Export growth in 2009 will reach just 3.5 percent,
and even if the global economy picks up, China's export
growth in later years will not be much more than eight
percent, far short of the 20-30 percent rates of recent
years. Dollar said it would not be effective for China to
attempt to maintain export levels through exchange rate or
tax (VAT rebates) policies. The Bank also is concerned that
very poor economic statistics for the first quarter of 2009
might negatively impact confidence.


5. (C) Despite these concerns, Dollar said China is in much
better shape than most countries to weather the crisis, as it
has good "fiscal space" and very large reserves. The Bank

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supports China's RMB four trillion stimulus plan, but
believes the infrastructure projects chosen for funding
should be ones that support future growth, such as
environmental protection, transportation, and universities.
The Bank also is concerned that this infrastructure spending
will not provide sufficient help for the millions of idled
export industry workers, who will need a "new social safety
net." Many unemployed migrants will choose to remain in the
cities, even without jobs, where they will need access to the
social welfare systems; this not only would be good social
policy, said Dollar, but also generate an immediate economic
stimulus as the workers spend their benefits on consumption
of domestically produced goods.

Senior Leaders Agree
--------------

6. (C) According to Dollar, World Bank President Zoellick
conveyed similar views to President Hu Jintao and other
senior leaders during his recent visit to Beijing, and those
leaders "reacted positively." The Bank's main worry in this
regard, however, is that China's leaders have "good vision"
that might not be shared by many local officials. For
example, provincial and local governments submitted project
proposals to the central government totaling RMB 40 trillion,
for the new four trillion stimulus package.

ADB: China Needs to Re-balance
--------------

7. (C) The ADB's views on China's economic situation and
outlook closely parallel those of the IMF and WB. ADB
recently lowered its 2009 GDP growth forecast from 9.5 to 8.2
percent. Economist Lommen noted a recent Chinese Academy of
Social Sciences (CASS) study suggesting the real urban
unemployment rate has risen to 9.4 percent, far higher than
the official statistics. With many small- and medium-sized
enterprises going bankrupt and a growing number of large
enterprises laying off workers, together with large numbers
of new graduates unable to find jobs, the real impact of the
slowing economy will be felt sometime after the Chinese New
Years' holiday. The ADB agrees that the fiscal stimulus is
timely and will help in the short term, but also believes
that China clearly needs to re-balance its economy in the
medium and long terms. Like the WB, the ADB also is
concerned about public and media reaction to bad economic
performance reports in early 2009.

CICC: The Negative Scenario
--------------

8. (C) As the only "private sector representative" in the
discussion, CICC chief economist Ha offered a significantly
more pessimistic view of China's economic situation and
near-term outlook. He said the challenges China now faces
are far greater than those during the Asian financial crisis
of the late-1990s, and China also will recover much more
slowly this time. First, the external impact and China's
reliance on external demand are much greater than ten years
ago. Second, private sector demand now is much weaker than
in 1998, when housing reform had just opened the property
sector and provided a strong multiplier effect for stimulus
spending. By contrast, the property sector now is
"crumbling" and will cripple other sectors (construction,
power) if it falls further. Third, China's infrastructure
now is much more developed, so stimulus spending on projects
will provide good social returns but less economic benefit.


9. (C) Ha predicts China will fall into deflation in 2009.
CICC estimates real 2009 GDP growth at 7.3 percent, including
negative 3.5 percent export growth, with 1 percent deflation.
He said "there is no basis" for the oft-repeated claim that
China's GDP must grow by at least eight percent annually to
maintain social stability; "seven percent would be fine."
Deflation will be caused by sharp declines in raw material
prices and weak domestic demand. Wage levels are falling,
and rising unemployment will depress them further. CICC
estimates 2009 PPI and CPI at negative six and negative one
percent respectively, which Ha said would have a "devastating
impact" on firms faced with falling revenues without
deflating debts. Non-performing loans (NPLs) also will
increase.

More Policies Please
--------------

10. (C) Ha said China will not be able to "bottom out" in
2009 unless additional government policies are implemented.
The U.S. economy will not bottom out until end-2009, while

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Europe's recovery will be more prolonged, so export demand
will remain depressed. He said the RMB four trillion
stimulus is "great" but will only increase GDP growth by one
percent annually in 2009 and 2010, after which the private
sector will have to "fill the gap." Within a few years, Ha
expects the world to enter a prolonged period of high
inflation, during which developed countries, highly indebted
with aging populations, will attempt to "inflate away their
debt." China cannot expect strong growth in its exports, and
hence will need to rely instead on greater domestic
consumption.


11. (C) To maintain social and financial stability, Ha said
China should give direct financial support to its poor
citizens. The rest of the world is pursuing monetary
expansion, so China will need to cut interest rates again
soon (it did so December 22) and pursue modestly expansionary
monetary policy with M2 growth around 15 percent. (Note: The
official Chinese M2 target is 17 percent. End note.) China
should not allow the RMB to depreciate against the USD, said
Ha, because that would trigger massive capital outflows at a
time when China needs capital. The government should cut the
VAT and make mortgage interest deductible from income tax,
while also imposing a property tax. To stimulate
consumption, China could issue shopping coupons for selected
groups (retirees, unemployed, students). Construction of
low-cost public housing should increase. In the long term,
China needs further reform in the health, education, and
social security systems, as well as deregulation and
de-monopolization in the telecommunications, energy, public
transport, and health sectors.

Comment
--------------

12. (C) One striking aspect of this discussion was Ha
Jiming's relatively pessimistic view of China's near-term
economic outlook. We rarely encounter a Chinese economic or
financial official, or even an economist, who will suggest
that GDP growth might dip below the eight percent threshold
they believe necessary for preservation of stability. A
second interesting point was that following Ha's
presentation, both the World Bank and the IMF -- whose
prepared points largely echoed their comments delivered a
week earlier at a public conference -- conceded that this
more negative scenario was indeed possible. The Bank added
that we should not think that an economic recovery in 2009 is
automatic; further policy measures, as well as effective
implementation of steps already taken -- including the fiscal
stimulus package -- are needed as well.

Randt