Just a few months ago, financial markets fell after Beijing cut the economy's growth target for this year to an eight-year low of 7.5 per cent. On Friday second-quarter growth came in at 7.6 per cent, a shade lower than expected, and markets rose. That says something about how much major Western economies now look to China to sustain global growth. The headline growth figure remains robust by other countries' standards, reflecting spending by state industry and government-directed investment. The private sector is bearing the brunt of the slowdown.
It was the weakest quarterly performance for three years. But it is likely to have been the worst, with a recovery expected in the second half of the year following policy loosening and stimulus measures. Nonetheless the result raises expectations that the government will take measures to further stimulate domestic demand and maintain economic stability ahead of a once-in-a-decade leadership change this year. That prospect too has reassured global markets.
More cuts in interest rates to lower borrowing costs are likely in the near future, as well as to the ratio of reserves that banks must hold, in order to increase liquidity. The central bank recently cut interest rates twice in a month, and has called on lenders to increase funding to companies to support the real economy. Premier Wen Jiabao said last week that sustaining investment was most important at this point, as efforts to boost consumption and exports take time to gain traction. He has pledged to revive investor confidence.
With other drivers of growth such as exports losing steam, pressure is mounting on Beijing to do more to stimulate consumption and cut taxes for small and medium-sized enterprises, the sector that creates new jobs. There will also be rising calls to boost spending on infrastructure, as Beijing did with its massive stimulus package to combat the financial crisis. The government should think twice before going down that road again. There is a strong argument that this is the time to initiate meaningful structural reforms to reduce dependence on exports. Such adjustments can be painful, but it is even more difficult to win support for them during boom times.
With fragile growth and uncertainty in China's main markets casting a shadow over future demand, it needs to boost domestic consumption. As Wen has said, this is the key to sustainable growth. The reforms necessary to stimulate innovation and movement up the production value chain, including liberalisation of the banking sector so that private capital can play a greater role, would put the economy on a healthier, more sustainable growth path. They will encounter resistance from vested official and business interests. But at this critical juncture, there is no alternative to resolute restructuring to maintain lasting growth and stability.