Source: The Wall Street Journal Asia                        Date: 27 October, 2010

Signs are building that China's government is retreating from the single-minded focus on high growth that pulled it through the global financial crisis, and is instead emphasizing structural changes that could contribute more to expansion and jobs in the struggling West. China's gross domestic product rose 9.6% from a year earlier in the third quarter, slowing from 10.3% growth in the second quarter, official data issued last week show, as the government withdrew stimulus and took measures to cool sectors such as the property market.

How China manages its economy is an issue of global concern, with the nation representing one of the few sources of strong growth. While the recovery produced by the nation's huge stimulus plan has been welcome, many of its trading partners still want to see a change of course. The U.S., for instance, has pushed for freer domestic markets and policies to boost incomes, so Chinese consumers can buy more imported goods. Particularly contentious is China's exchange-rate policy: Many countries complain that China, by intervening to hold down the value of its currency, supports its own exporters to the detriment of others.

China's government has repeatedly said it will do more to boost consumer spending and cut its trade surplus, but those pledges haven't been backed up with many concrete changes. There are now signs that such priorities have gotten more backing, as authorities allow the recent boom in heavy industry and investment to cool. Data published last week showed that the rebound in growth, which has been largely driven by state-backed credit and investment, continued to ease in the third quarter of 2010. The expansion in gross domestic product slowed to 9.6%, from 10.3% in the second quarter, as gains in capital spending fell back to levels last seen before the launch of the stimulus program in late 2008.

But even before those data were published, authorities had signaled that the ultra easy policies adopted in the crisis years are on their way out. China's central bank raised benchmark interest rates earlier last week for the first time since December 2007. China's currency is now rising at its fastest pace against the dollar since 2008.

The apparent change in course for the world's fastest-growing major economy came just after the ruling Communist Party reached agreement on economic priorities and the political succession in coming years, and many observers see a new approach at work. "We think the government will tolerate a lower rate of growth but will aim to significantly improve the structure of the economy," said Deutsche Bank economist Jun Ma. The interest-rate increase—unusual because it came at a time of slowing growth—"is a very important signal that a policy consensus has been reached," he said.

China's top Communist Party leadership closed a high-level conference Monday last week with call for "accelerating the transformation of the nation's economic development pattern" and "putting more emphasis on securing and improving people's livelihood to promote social equality and justice." A communique said those priorities will be inscribed in the nation's next five-year plan, which is now being drafted for publication next year.

With the next summit of the Group of 20 major economies just weeks away, China is under increasing international pressure to run its economy in a way that supports recovery elsewhere. And the "transformation" leaders endorsed refers to efforts to make Chinese economic growth less driven by exports to the West and the loan-fueled investment that has been at the center of its stimulus plan.

Though China helped lead the world economy out of the worst of the crisis, the government is now dealing with some of the costs of the drive to keep growth high: huge debts of uncertain quality in the state-owned banking system and a bubbly housing market that is fueling urban discontent.

Officials hope the consumer spending of a rising middle class will provide a more sustainable source of growth for the future. A consumption-driven Chinese economy would probably grow somewhat slower, analysts say, but be less prone to boom-and-bust cycles and shocks from abroad—a trade-off many see as worth making.

"To emphasize domestic demand is a firm policy of the Chinese government, and this is a comprehensive policy from all directions," deputy central bank governor Yi Gang said at the International Monetary Fund's annual meeting earlier this month. He said the government will help drive domestic consumption through supporting urbanization; reducing income inequality; improving social security, health care and education; and boosting infrastructure in rural areas.

The leadership's emphasis on structural overhauls over stimulating high growth rates is based on confidence in the economy's prospects, government advisers say. "We're not worried about China's short-term growth prospects. China has great domestic growth drivers," such as the urbanization of its rural population, said Hu Angang , an economist at Tsinghua University who has advised the government on its five-year plans.

But the new direction also recognizes the growing consensus among academic economists that China is unlikely to sustain its recent 10%-plus growth rates as its economy becomes increasingly large and mature. The effects of the financial crisis also continue to weigh on the U.S., Europe and Japan, which means their demand for Chinese exports is unlikely to grow as robustly in the future as in the past.

"Based on fundamentals, it seems likely that China's growth rate will ease. Growth in the coming 10 years is probably going to be less than in the previous 10 years," said Louis Kuijs, an economist at the World Bank's Beijing office. "The government could boost investment to offset those fundamental forces, but it's deciding not to do that."

The priorities for the next five-year plan that the leadership presented this week will "help us adjust our economic structure at a faster pace, raise the quality and efficiency of economic development, and improve people's livelihood," Sheng Laiyun, spokesman for the National Bureau of Statistics, said Thursday. The next five-year plan will de-emphasize old-style quantitative targets, he said, which will help "dilute" some of the negative impact those have brought in the past.

Skeptics note that the latest economic data provide little evidence that China has shifted away from a free-spending stimulus policy. "Strong investment supported by easy money, record exports underpinned by a depreciating yuan, and retail sales that are driven by incentives to spend represents more of the same, not a shift in the growth model," said Tom Orlik, an analyst in Beijing for Stone & McCarthy Research Associates.

The slowdown in growth has so far been very modest, with industrial output—an important indicator in China's manufacturing-heavy economy—still up 13.3% from a year earlier in September, after August's 13.9% rise. A sharper deterioration could test how willing the government is to let growth find a natural floor. On the other hand, a pickup in broader inflation—the consumer price index was up 3.6% in September after a 3.5% gain in August—helps the argument for higher interest rates and a stronger currency.

Even if the government succeeds in its goal of consumer-driven Chinese economy, there are questions over how much support to the world economy would be delivered even by the most free-spending of Chinese households. "Even in a best-case scenario, however, China will provide only a partial offset to the weaker demand from advanced economies, given the relatively small size of both overall Chinese consumption and Chinese imports of consumer goods," the International Monetary Fund said in its latest assessment of the world economy.