China’s economy expanded only 6.8 percent in the fourth quarter of 2008, the slowest pace in seven years. The main factor behind the slowdown has been the deterioration in industrial production caused by slowing exports and declining in property investments. In fact, China’s exports growth has dropped more than 20 percentage points from 19.1% in October to negative 2.8% in last December 2008. To make things even worst, internal demand seems to be weakening. Although, official data implies the retail sales has held up well so far, there is a substantial amount of downward pressure on private consumption from weaker income growth and a negative wealth effect.
However, even though there are plenty of reasons to be pessimistic, the Chinese economy has a big chance of returning to the previous pace of growth if the government implements the right combination of monetary and fiscal policy measures. In fact, China has already reduced export taxes and is adding support for key industries including tax cuts and subsidies for steel and autos. Moreover, a series of interest rate cuts, the removal of loan quotas and a variety of actions taken by the government to encourage loan extensions have already been reflected in the credit growth which rebounded at the end of 2008. More importantly, a 4 trillion Yuan (US$585 billion) stimulus package could bring a big boost to domestic demand and trigger a nationwide recovery.