Despite assurances from top government officials that China will survive the global credit crisis relatively unscathed, the country's economy is cooling rapidly. In the third quarter, gross domestic product growth fell to 9 per cent, year on year, from 10.1 per cent in the second quarter and 12.2 per cent a year ago. For many ordinary Chinese, evidence of the deceleration is everywhere. Bears have had the stock market in their grip for months. The drop in both transactions and prices of properties shows no sign of reversing and is spreading from first-tier to second-tier cities. And factory workers in low-end export manufacturing are losing their jobs by the day. The Chinese government is now under increasing pressure to step in and stimulate the economy. The question is: how?
Broadly speaking, governments have three main policy tools to tackle an economic downturn - interest rates, the exchange rate and fiscal spending. In the longer term, Chinese leaders are most likely to turn to the fiscal lever. But in the short term, they will probably focus on reviving the property market.
Why? After rapid development in recent years during which the property market helped fuel a boom in everything from construction to home appliances and cars, its travails are now having a reverse effect on those industries. Property prices in China are still by no means low, even by the standards of some developed countries. Valuations based on both affordability and rental yields are severely overstretched.
Even so, should the stagnation in the property market continue, banks may see their bad loans jump while local governments will face shrinking tax revenue. China's overall economy could then slide into a deeper downturn.
That said, China does not suffer from a subprime mortgage problem. Most homeowners are conservative and do not carry high debts. Unlike in the west, the cost of mortgage default is prohibitively high. This gives the government some room for manoeuvre. To breathe life into the property market, it could relax lending restrictions on mortgages, including making second mortgages easier to obtain. Interest payments on mortgages could also be made deductible on personal income-tax returns. The government has already slashed the minimum down-payment requirement to 20 per cent from 30 per cent to 35 per cent, and property-transaction taxes to 1 per cent.
Alas, the government may find that none of this is enough to get people to start buying again. A recent survey by sina.com showed that most people still think property prices are highly overvalued. This suggests that any bottled-up demand is unlikely to revive until there is a further price correction.
This is why the Chinese government must pursue other longer-term measures to sustain growth. Yet aggressive monetary easing (including allowing the yuan to weaken) may do little to change investors' extreme risk-aversion, as evidenced by the market reaction to the ongoing bank bailouts in the west. That leaves expansionary fiscal policy. The recent decision to do away with taxes on interest income from bank deposits is a step in the right direction. To put even more money in people's pockets, the threshold for the personal income-tax exemption could be raised to 5,000 yuan (HK$5,684) a month from the current level of 1,600 yuan a month. And if the government wants to raise food prices to boost rural incomes, it must dish out more subsidies to the urban poor at the same time. To assist hard-pressed businesses, especially small and medium-sized ones, the government should relax the implementation of the controversial Labour Contract Law, in addition to extending more generous export-tax rebates, as it has already done.