At the end of November in 2002, it was 0.8 percent down from a year earlier. The lower prices, however, seem to have cheered up consumers, much less significantly than they have frustrated economists.

The Chinese are still grumbling about the high prices of cars and homes and keep saving enthusiastically, while economists lament the current price downturn as persistent and widespread.

Price falls are presumably unfavorable to China maintaining its robust economic growth, which has been primarily powered by investment, spending and exports. More obviously, they pose a challenge to the government's monetary policy goal of "maintaining stability in the value of the currency."

What is bugging economists more, however, is the structural and systemic problems behind falling prices. Wide-ranging reforms over recent years in housing, welfare, insurance, pensions and employment have dramatically increased uncertainties in future expenditure and enforced a conservative spending mentality.

At the other end of the market, duplicate construction has resulted in widespread overcapacity.

These factors, analysts say, augur ill for the CPI outlook for the coming two years and call for a more active monetary policy.

"Obviously, in a time of continual falling prices, it's inappropriate for us to keep a stringent monetary performance only because of excessive inflationary concerns," says State Information Center analyst Li Ruoyu.

Stronger monetary support is especially crucial to economic growth in a year when the stimulative effect of a pro-active fiscal policy is set to subside further as government deficit climbs and revenue growth slackens.

Monetary supply growth quickened last year, although the central bank retained its rhetoric of a "prudent" monetary policy.

That could well suggest the possibility this year of a further pickup, or at least keeping last year's level in the growth of broad measurement M2, or cash in circulation plus all deposits.

Faster-than-expected rises in loans pushed up real M2 growth and forced the central People's Bank of China (PBOC) to raise its annual growth target twice last year.

This year, if money supply is to grow faster to fuel growth, loans, which contribute about 70 percent of money supply, also need to accelerate and the central bank is expected to take the initiative by encouraging lending, analysts say. Containment of financial risks is of great importance in the process, but over-prudence in lending may lead to an unwanted shrinkage in economic activity and amplify commercial banks' operational risks, they warn.

The prospect of the central bank opting for another interest rate cut this year to boost lending remains dim, as the current level - with the one-year deposit rate at a decades low of 1.98 percent - leaves little room. But lending rates could well be allowed a broader range to float, which would give the risk-averse banks stronger incentives to lend.

There is more room in lowering the interest rate the PBOC pays to commercial banks on their deposits reserves, however.

As bank assets increasingly diversify and promising loan projects remain in short supply, commercial banks' deposit excesses hit 3.4 trillion yuan (US$409 billion) at the end of June and their payment reserves continued to grow to a peak of 7.9 percent of total deposits for the year.

Another monetary policy tool, or the PBOC's rediscounting commercial bills from commercial banks, may also lend a hand should the central bank lower the rediscount rate to spur the inert business. The rate was raised to 2.97 percent from 2.16 percent in September 2001, squeezing profit margins at commercial banks and bringing the operation to a near standstill.

The outstanding rediscount volume started to shrink month by month, to 1.2 billion yuan (US$144.5 million) in September last year from 96 billion yuan (US$11.5 billion) a year earlier.

Other economists attach more importance to the quality of money supply, urging the government to channel more funds into the underfunded small and medium-sized enterprises (SMEs) and the vast rural areas.

"The problem is not if the monetary policy is strict or loose," says professor Xu Guangjian of the Renmin University of China, "but about reforming banks' operational mechanisms and the funding needs of microeconomic entities."

China's vast SMEs are still suffering a funding anemia as major commercial banks focus on big business. An anticipated acceleration in the development of the country's 110 city commercial banks, which lend more than 80 percent of their loans to SMEs, promises to alleviate that funding shortage in the years to come.

Central bankers made it clear late last year that private and foreign investors are encouraged to take equity stakes in city commercial banks.

More needs to be done in the countryside to fill widening funding gaps partly created by post offices' enhanced absorption of savings that were redeposited at the central bank.

(China Daily January 6, 2003)