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Big boom theory: Yuanzheng Cao, chief economist at Bank of China International, recently addressed the inaugural CIMA world conference in Colombo. In the following edited extracts of his speech, he analyses China's "economic miracle".

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In the 30 years since China adopted its open-door policy to foreign direct investment (FDI), the country's economy has exhibited the following main features: strong, sustainable GDP growth, low inflation and high employment, especially in urban areas.

Three decades ago China was a poor, backward nation. Its share of global GDP was five per cent. Today it's 13 per cent and we estimate that the country will become the world's largest economy by 2020. The most important engine of this economic miracle has been industrialisation. Manufacturing has grown faster than any other sector and the number of urban workers has increased rapidly alongside this. Shanghai, for example, is now home to more than 18 million people.

In 1978 the government set out to transform a highly centralised economy into a market economy. It also tried to free prices and set up flexible financial systems. Today all prices are governed by market forces, not by government orders, and the state-owned sector contributes only 20 per cent of GDP.

China has not only a domestic banking market but also a capital market, which last year became one of the largest in volume. The open-door policy has attracted so much FDI that the country is now the world's number-one FDI destination. To balance the influx of foreign currency, the government stimulated exports, so now China is also the world's number-one exporter.

The challenges that will affect China's economy in future include the following:

* Limited natural resources.

* The transition from oversupply to limited supply in the labour market.

* Increasing production costs and inflationary pressures.

* The structural imbalance in the economy, especially in terms of its largest foreign currency reserve. Consumption is declining. Demand now depends on inward investment and this makes the economy overheat.

* The disparity of income distribution: the coastal region is rich and west is poor. Rural poverty is a big problem already and social welfare systems are undeveloped.

* A financial system that needs strengthening--the fluctuation in asset prices is creating risks. Because the economy is booming and FDI is rushing in, the Chinese reserve is going up.

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This century China has joined the World Trade Organisation and its exports are continuing to boom. The government is attempting to reform the renminbi regime by adopting a flexible exchange rate and turning the renminbi into convertible currency.

China is the most open economy in the world, in GDP terms, China's imports plus exports make up 17 per cent of its total GDP which is a higher percentage than that of the US, Russia or India.

Since it is a large exporter with low prices, China has helped the world economy to avoid inflation and has made consumer goods even cheaper. But at the same time it has suffered from this increase in exports because it has created a commodity boom that has driven up prices. Now China is also becoming the largest country for imports. So on one hand China has become a big market for commodities and on the other it suffers from a shortage of raw materials and rising prices for these. It's two sides of the same coin.

China once adopted export-orientated policies, but now it is trying to move away from promoting exports and towards increasing domestic consumption. The following things are happening:

* Current account: China is encouraging imports while at the same time trying not to reduce its exports.

* Capital account: we will try to move from relying on FDI to increasing the capital market to encourage foreign funds to come in this way. As a result, the country is changing from policies that promote quantity to those that promote quality.

* The government has encouraged people to use US dollars by opening personal accounts. Each Chinese citizen can buy $50,000 in one year.

* It has tried to eliminate some restraint from the capital account. According to the International Monetary Fund, it has removed nearly half of the restraints.

Also in the current account, China has adopted inward policies and aimed to become the world's biggest market by doing so. For example, this year the government has integrated tax, so joint ventures have benefited. It has encouraged exports of services including labour, while increasing its high-end technology imports.

It has introduced reforms to establish minimum salaries and a lower rate of export tax rebate. It has also put tighter regulations on the price of land and the use of resources. Since last year, the government has promised to reduce energy use by four per cent a year.

It also wants to rebuild the renminbi exchange rate system. This has appreciated by 18 per cent until now. We estimate that in next three to five years it will continue appreciating by three to five per cent a year. This fluctuation will need a flexible exchange regime and fully convertible currency.

These changes will create a new balance in the world, especially with regard to Sino-US relations. At the moment China has a large reserve invested in the US, so the US trade deficit becomes China's export surplus and this kind of surplus becomes a US capital inflow. The two countries cannot reach an internal economic balance by themselves--they need to co-operate. Each one must balance its economy with the other's. This lays the foundation for dialogue between the two nations. It's a balance that we have never seen before. But it is still not stable, so we have to do something to stabilise it--for example, by using the international monetary system.

In order to overcome a shortage of energy supplies we are adopting policies to conserve energy and encourage innovation and technology in this area. We will reduce our energy use by four per cent a year and will encourage new production--eg, nuclear, wind and solar generation. China is becoming the largest consumer of wind power in the world.

And still China will open its doors to the outside world. The country once contributed to the world through its exports. Now it will contribute to the world through its imports. It will try to be the world's largest market by adopting policies to encourage consumption. We're confident that in the next decade China will become the world's largest market.
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Author:Cao, Yuanzheng
Publication:Financial Management (UK)
Article Type:Conference news
Date:Sep 1, 2008
Words:1034
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