ProjectTeam on Analysis of Macro Economy*

I. Analysis of the Economic Situation in 2006

The major features of the economic situation in 2006 include: the overall level of the economic growth increased over last year, and the economic performances showed a trend of declining after rising and remaining stable at the high level. Increase of investment fell back at the high level, featuring declining after rising and falling back at the high level. Consumption was further activated with the growth going up continuously. Upgrading of consumption structure was active. Foreign trade surplus continued to enlarge, reaching 109.9 billion US dollars from January through September, up 60.4% over the same period of the previous year. Commodity prices increased by a small margin, and the industrial enterprises realized an increase of profits and an improvement of beneficial results.

Under the impact of both macro-control and market mechanism, since the later half of 2006, economic performance remained stable as a whole, with little possibility of continuing to fall back notably or bouncing back within the year. The main facts are: First, the factor of demand supporting the fast economic growth has appeared to be strong, and consumption, in particular, tends to be more active, thus bringing more motive power to the development of such terminal industries as housing and transportation as well as numerous small and medium-sized enterprises; foreign trade surplus continues to expand, driving forth the domestic industries, especially the labor-intensive industries. Second, the low increase of prices suggests that the market competition has become more fierce, putting a strong restraint on the market-oriented production and investment. Third, enterprises have much adapted themselves to the competition environment and improved their ability to develop on their own. Since the year 2006, some industries which used to be considered in excess of production capacity have scored new development after structural adjustment, with the beneficial results improving evidently. From January through August, output of cement rose 21% year on year, output of pig iron rose 18.6% year on year, and the output of the electrolyzed aluminum rose 18.25 year on year. Meanwhile, from January through August, profits realized by the cement industry rose 135% year on year; profits realized by the aluminum smelting industry rose 143.7% year on year. Fourth, the investing boomfostered by local governments has been initially curbed. The year 2006 is the first year of the 11th Five-Year Plan, and as election will be held this year for local governments and Party committees on expiration of office terms, investment boom encouraged by local governments has shown up again. In light of such a situation, the central government has adopted a series of controlling measures since this year, focusing on strengthening control over the newly started projects and input of medium and long-term loans, as well as over energy consumption and environmental pollution and has enforced strict management of incomes from land supply, land approval and land leasing. It can be seen from the declining of investment growth that those measures have resulted in preliminary good results. According to the forecasted results from the metrological analysis model and the our qualitative estimates of various kinds of factors, it is predicted that the GDP growth rate for the whole year will be around 10.5% and the prices of household consumer goods will rise within 2%.

II. Some Tangible Issues that Merit Attention

1. Foreign exchange reserve is too big in scale and increases excessively fast

Over recent years, China's foreign exchange reserve has increased rapidly and further increased since 2006. At the end of 2002, China's foreign exchange reserve amounted to 286.4 billion US dollars and increased to 818.9 billion US dollars by the end of 2005, with an average annual increase of 177.5 billion US dollars; in the first half of 2006, the reserve increased again by 122.2 billion US dollars. The proportion of foreign exchange reserve to total import and export value in the same year rose from the 46.14% in 2002 to 57.6% in 2005. The continuous and rapid growth of foreign exchange reserve reflects the growing imbalance of payments in the world, which is unfavorable to the stability of foreign exchange rates and the foreign trade and foreign investment environment, and has resulted in the prodigious amount of money input in foreign exchange settlement channels. The excessively big scale and overly fast growth of foreign exchange reserve is one of the conspicuous issues affecting macro-economic equilibrium at present and in the days to come.

Growth of foreign exchange reserve is mainly driven by two elements: one is the expansion of foreign trade surplus and the other is investment from abroad to China is bigger than China's investment to foreign countries. Driving force of the two elements will remain for some time in the future, but will tend to be weaker.

From the perspective of foreign trade, it can be seen that there is still a big potential for China to be advantageous in labor force resource, the space for the development of processing trade is still big and export will still maintain a fast growth; meanwhile, under the influence of the keen competition in domestic market and the change in the structure of imported goods ( import of resource products and hi-tech products has increased, while import of goods of ordinary technology has reduced ), room for import growth is not big. As a result, the pattern of trade surplus will still remain for a period of time. However, it needs to be pointed out that elements for restraining export from increasing and for stimulating import to greater development have been gradually enhanced. Such elements mainly include: First, demand on the world market in the future will enter into a cyclical shrinking period. Research findings show that growth of import by China's major trade partners (15 countries of Euro area, USA, Japan, South Korea and China’s Hong Kong SAR) has a cyclical fluctuating phenomenon of 5 years, after December of 2004 import demand of the major trade partners has entered into a cyclical shrinking period, with the growth rate falling continually from 18.2% in December of 2004 to 13.88% in July of 2006. It is estimated that the growth rate for the whole year of 2006 will reach only 13.45% and will further drop to 11.29% for the whole year of 2007. Second, the continuous appreciation of Chinese RMB will curb export and stimulate import. Compared with June of 2005, in September of 2006, the nominal rate of RMB to US dollar appreciated by 4.56%, the nominal effective exchange rates of RMB appreciated by 4.51% and the real effective exchange rates of RMB appreciated by 2.71% ( July of 2006 ). The continuous appreciation of RMB in the future will result in the slowing down of export growth. Third, the policy factor such as cancellation of export tax refund for high energy-consumption goods has curbed the export of part of the products. Fourth, world trade conflicts have aggravated, leading to the declining of the export growth of some products. Fifth, increase in import of raw material and the drastic rise of prices have increased the import value. For instance, in 2005, import of iron ore and concentrates increased by 32.3%, with the average unit price rising 9.4% and the import value growing 44.7%; increase in import of crude oil and oil products has been low, even reduced ( 3.3%--17% ), but the average unit prices rose 36.3% and 36.1% respectively, and the import value rose 40.7% and 12.9%.

From the perspective of the utilization of foreign investment, it can be seen that China’s economy has grown continually and rapidly, prices of labor force and land are low and the investment environment has been improved continually, which will continue to attract foreign investment to China; meanwhile, under the influence of RMB appreciation and the gradual adjustment and improvement of the policies for foreign investment utilization, it can be predicted that foreign investment scale will tend to be stable. According to statistics of Foreign Investment Express, from January through September of 2006, the used foreign investment value across the country amounted to 42.6 billion US dollars, down 1.5% year on year.

To sum up the above-mentioned two cases, within a period of time in the future, foreign exchange reserve will still continue to increase, but the pace will gradually slow down. The imbalance of payment is estimated to be intensified, which needs longer time to deal with. Under such circumstances, short-term policy measures should be adopted to stabilize the macro-economy and medium and long-term strategies should be worked out to solve the contradiction of imbalance of paymentas well.

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*Members of the Project Team include XieFuzhan, Liu Shijin, Lu Zhongyuan, Zhan Liqun, Li Jianwei, JinSanlin, Han Jun and Qin Zhongchun.