China Draws Plan to Reduce Risk While Continuing Economic Growth

Chinese Premier Wen Jiabao on Friday pledged to maintain economic growth of at least 8% in 2010, while gradually drawing down government spending and taking measures to guard against inflation and potentially devastating asset bubbles.

The remarks came during Wen's annual report to the National People's Congress in Beijing - which is the equivalent of the United States' State of the Union speech - and they highlight the central government's determination to promote responsible levels of growth.

The call for 8% annual economic growth is the same goal that has been maintained since 2005 - and one that was easily passed last year with the implementation of a sprawling $586 billion stimulus package.

China's economy expanded by 10.7% year-over-year in the fourth quarter as most of the world continued to struggle with the aftermath of 2008's financial crisis. For the full year, the nation's gross domestic product (GDP) grew 8.7%.  

That easily topped the government's 8% target and dwarfsd the economic growth posted by other economies around the world. Wen championed this achievement, but he also made it clear that the central government is aware of the risks posed by the very lending that fuelled the economy's growth.

"Latent risks in the banking and public finance sectors are increasing," he said.

Lending, which was spurred by the nation's massive stimulus, soared out of control as the nation rebounded from the world's strident economic downturn - particularly in the first six months of 2009. China's banks lent out about $1.08 trillion (7.37 trillion yuan) in the first half of last year, nearly double the total loans extended throughout all of 2008. A record total of $1.4 trillion (9.59 trillion yuan) was lent out for the whole of 2009.

That surge in lending fuelled China's rapid growth in 2009, but now it risks overheating the economy, leading to a rise in inflation, and adding fuel to a real estate sector that is already on fire.

China's consumer price index (CPI) fell 0.7% last year but this year is targeted to rise by 3.0%. Economists predict it could peak at 4.4%, with the full-year rate around 3.4%. Wen's goal is to remain under a 3.0% target.

"Three percent is a fairly aggressive target and it suggests that the government will need interest-rate increases and price controls to achieve it," said Ma Jun, a Hong Kong- based chief China economist at Deutsche Bank AG, to Business Week.

China is well aware of concerns and has already taken measures to manage rising inflation. In January, the People's Bank of China drained a net $20.1 billion (137 billion yuan) from the money market through its open-market operations.

But inflation isn't the government's only concern. Wen also must put a lid on real estate prices, which are being pushed sharply higher by investor speculation and sowing the seeds of an economic bubble.

China's home prices in 70 large- and medium-sized cities, a housing price trend barometer, climbed 9.5% in January from a year earlier - the fastest growth in 19 months. January's property price climb was the highest in 21 months.

"When you sit down with a table of businessmen, the story is usually how they got lucky from a piece of land," Andy Xie, an independent economist who once worked in Hong Kong as Morgan Stanley's (NYSE: MS) top Asia analyst, told BusinessWeek.

However, escalating land prices are making homes unaffordable for the middle class. So the central government this year is seeking to reduce new loans by 22% to $1 trillion (7.5 trillion yuan).

"We will resolutely curb the precipitous rise of housing prices in some cities and satisfy people's basic need for housing," said Wen.

China also will be reducing the debt of local governments, who usually do not carry debt, but had set up investment vehicles to borrow from banks to further contribute to the economy's growth. 

"We will strengthen the fiscal management system at and below the provincial level, set up a mechanism to ensure basic funding for county governments and carry forward reforms that place county finances directly under the management of provincial governments," said Wen.

Government spending will rise 11.4% -- only half as much as 2009.  Healthcare, education and social security spending will all rise at lower levels than last year, and China warned that project start-ups would be strictly controlled.

"The bottom line is that China's leaders are focusing on financial-crisis solutions..." said Money Morning Chief Investment Strategist Keith Fitz-Gerald. "If anything, the moves that China is making amid so much criticism are actually going to solidify the long-term future of the world's No. 3 economy."

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