By Dan Luo.

The number 2012 originated from an old Mayan legend and has become famous because of the cognominal Hollywood movie “2012”. Will reality be worse than drama? Will it be the year of a hard landing for China?

Reports from China International Capital Corporation (CICC) and Goldman Sachs both forecast a GDP growth rate of about 8.5% for China in 2012 and the latter further emphasises that “the probability of China falling into a hard-landing scenario on its own problems is low”. Why then are so many people still worried? What are the most serious challenges that China would face in year 2012?

It has been generally agreed that China’s growth has long been driven by three impetus, investment, export, and foreign direct investment (FDI) and such a mode is unsustainable.

The two biggest markets for Chinese goods, the European Union and the US are struggling economically. Their gloomy economic prospects and high unemployment rates have significantly reduced demand for products “made in China”.

The overall growth of foreign trade in China is estimated at 14%-15% for 2012, 7%-8% lower than the year past. If accompanied by rising trade protectionism, surging labour and production costs, additional expenses incurred to tackle environmental damage and increased pressure on RMB appreciation, the situation will get worse.

The prospect of China’s other growth engine, investment, does not look more promising either. Fixed asset investment in China has grown at an extremely high rate of about 25% during the past five years, and capital formation contributes to about half of the country’s GDP growth. However, its side effects have become increasingly problematic nowadays. The investment-led growth in reality means the fast development of the heavy industry, which causes severe pollution and impedes industrial structure transformation.

Over-reliance on investment and GDP growth has also hindered the healthy development of the private sector. A substantial amount of scarce financial resources have been channelled to real-estate development and infrastructure construction projects, leaving little for the private enterprises. As a result they have to rely on the underground money market for finance at much higher interest rate. This left the private firms with low profit margin and causes distortion to business decision making. Instead of repaying the loans, many business owners prefer to cash in their business and use the fund to invest in the housing or the stock market, where quick profit is possible. This has caused an oversupply of liquidity and pushed up inflation.

This has forced the Chinese government to rein in the housing market and curb inflation last year. In the face of slowdown in 2011, the Chinese Government dared not revive the 2008 policy to “increase investment as a way of stimulate growth”. It recognized the need to attempt an economic transformation in 2012.

 2012 is one of the most important yeas in China’s 12^th Five-Year Plan as it should set up the tone for the country’s growth pattern in the coming decades. China’s leadership will change hand and the new government will need to implement a series of new policies to tackle various problems embedded:

• Effective policies need to be implemented to ease funding for the private sector, in particular for companies engaged in high-tech, energy saving or environmental friendly businesses. This should increase tax revenue for local governments, create more employment opportunities and facilitate economic structure transformation.
• The orthodoxy that “GDP growth is king” needs to be eradicated both centrally and locally. More comprehensive assessment criteria should be applied to evaluate the performance of local governors.
• Tax reforms, which influence various aspects of the economy, will also be essential. They include adjustment of value-added tax, property tax and the scope and structure of the consumption tax, the expansion of resource tax reform and the implementation of environmental tax.

Dr Dan Luo is a Senior Fellow of the China Policy Institute and a Lecturer at the School of Contemporary Chinese Studies at the University of Nottingham.

Opinions expressed in the CPI blog do not represent the views of the China Policy Institute or the School of Contemporary Chinese Studies at the University of Nottingham. They are the personal views of the bloggers/authors.