Domestic Demand Crucial to Easing Trade Pressure

By staff reporters Hu Shuli and Zhang Jiwei

tremendous pressure on the yuan, but further appreciation of the yuan alone can’t change the situation, said Zhou Xiaochuan, governor of China’s central bank.

Last year, China registered a trade surplus of US＄32.1 billion. That figure has already doubled by the end of August this year, when it reached US＄60 billion. It is expected that it could exceed US＄100 billion by the end of this year.

“The trade surplus now is too high,” said Zhou in an exclusive interview with . “Judging from this year’s situation, it would be very difficult to reverse the trade surplus if we rely only on adjusting exchange rates,” he said. Even if China followed the Japanese example of devalue its currency by half, the situation wouldn’t change unless other factors are changed too, said Zhou.

While the growths of investment, consumption and overall GDP comparable to those of last year, export alone has seen a dramatic spike, Zhou said. “This is puzzling.”

Analysts are split on what has caused the dramatic rise in the surplus. Some hold that expectations for the appreciation of yuan have prompted exporters to deliver their goods ahead of schedule, for fear of losses in the wake of any yuan revaluation. On the other hand, they say, importers tend to delay reception of goods to bet on the possible yuan appreciation.

Ha Jiming, chief economist at China International Capital Corporation, supports this opinion, saying the speculative mood has led to China's soaring trade surplus in recent months.
But short-term foreign exchange fluctuations should not affect traders' decision-making, argued Huang Yuequan, assistant to the general manager of China National Machinery & Equipment Import & Export Corporation. Tao Dong, chief economist at Credit Swisse First Boston bank, said even if the yuan were revalued by 10-20 percent, it would not have had much impact on the country's huge trade surplus, given China's unrivaled advantage in labor cost.

Zhou admitted that rising surplus is a 'new problem' for macro-economy since it may incur more trade frictions.

'Seen from the growth trend of GDP this year, the contribution of net exports (to GDP growth) is rising while that of investment falls. The role of consumption in boosting GDP may further weaken. This may exacerbate trade frictions.' Zhou said China adjusted the value of yuan in accordance with the level of its trade surplus in the past five years, during which its annual surplus accounted for about 2 percent of GDP on average.

'Things have changed in 2005 and it now seems our trade surplus is too high,' said Zhou.
The value of yuan is subject to market changes and is currently about 8.08 against the US dollar. But changes in the nominal exchange rate alone will not resolve the soaring surplus. The more important method is to adjust the structure of the domestic economy, since domestic demand in a large economy is much more effective than foreign exchange adjustments in balancing trade, said Zhou.

Zhou said overall consumption growth has remained weak and its ratio to the GDP has been shrinking in recent years. As the state reins in investment, the Chinese economy would hinge largely on consumption as the main engine for growth.

'In the next three years, if domestic demand cannot be expanded, the Chinese economy would increasingly rely on exports to maintain its growth momentum, which would incur more pressure over issues as trade, exchange rate and intellectual property rights. They may inevitably been 'politicized,'' warned Zhou.

For China, Zhou said, a better solution is to fully bring out the consumption potential of higher-income families to jazz up domestic demand.

Economists once recommended that money be invested in rural areas to stimulate farmers' appetite for consumption. Zhou said further technical calculations is needed to decide to what extent measures of raising farmers' income could work in boosting their purchasing power.

'Relatively, I prefer to increase investment in rural infrastructure to improve rural production,' said Zhou.

Despite the rising income level of farmers as a result of labor migration to cities and increasing fiscal transfers to rural areas by the central government, farmers' purchasing power remains weak. It not now accounts for about 15 percent of China's GDP, and would not contribute significantly to stimulating demand, said Zhou.

For the ordinary Chinese, uncertain expectations about medical care, education, employment and housing have forced them to deposit more and spend. 'A more effective way of stimulating domestic demand may be to bring out the consumption ability of rich people,' Zhou suggested.

China's top 20 percent rich families account for about 40 percent of the nation's wealth, according to Zhou, while the lowest 20 percent on the wealth ladder possess only 6.4 percent. 'Morally disputable, but it is a fact that the purchasing power lies in the high-end group.'

Zhou suggested that China should shift its focus from material consumption to that of services, such as culture, sports, entertainment and travel.

Last year, China's tertiary industry accounted for 32 percent of its GDP, far less than that of other comparable countries, such as Russia, Brazil and India. 'The underdevelopment, on the other hand, also means China has great potential in this aspect,' said Zhou.

According to Zhou, people are often trapped in the misconception that the service industry refers to 'intermediary' industries only that support production, circulation and exports, such as call centers. Services targeted at ultimate consumption, such as sports, travel and property management, are ignored. 'And given China's realities, the country should develop more service industries that do not consume too much capital or materials.' Zhou said the most promising markets of the service industry in the future include culture, arts, sports, personal care, travel, entertainment and leisure. They do not produce much direct value, but has a strong spill-over effect for the overall economy, said Zhou.


Staff reporter Guo Qiong contributed to the story
English version by Xin Zhiming