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Why China must do more to rebalance its economy

The data coming out of China suggest a powerful recovery is indeed under way.  In the first half of the year, noted the premier, gross domestic product expanded 7.1 per cent. The September consensus forecasts suggest that the Chinese economy will expand 8.3 per cent in 2009 and 9.4 per cent in 2010.  The Asian giant is expected to become the world’s second largest economy in 2010, even at market prices.

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According to the Economist Intelligence Unit, domestic demand may expand by as much as 11.5 per cent in real terms this year. Such a surge in Chinese internal demand is exactly what was needed.  Chinese household consumption is also forecast to grow 9.3 per cent (see chart). Yet, as usual, real fixed investment is the locomotive. It is forecast to grow 14.8 per cent this year. If so, it would have grown faster than GDP in all but one of the past 10 years.  This rising ratio of investment to GDP, from an already high level, is not a strength but a weakness.  It suggests declining returns on capital. It risks creating ever-rising excess capacity. Moreover, when growth rates finally fall, the collapse in investment is going to knock a huge hole in demand.

The heavy reliance on investment is not the only risk ahead. So, too, is the surge in credit and money (see chart). Many believe this is bound to lead to another upswing in bad debt and destabilising asset bubbles. The jump in the ratio of broad money to GDP is also worrying, coming after a long period of stability.

via FT.com / Columnists / Martin Wolf – Why China must do more to rebalance its economy.

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