In the first half of this year, the Chinese economy seems to have remained strong with a low inflation rate. But we need to be cautious of potential problems impressive statistics fail to reflect.

The macroeconomic figures all point to a continued high-rate growth of the economy, which goes against previous forecasts by many economists.

Despite its overall strong performance, the economy is faced with some developmental imbalances. The slow-down in the growth of the Yangtze River Delta and the Pearl River Delta regions deserves particular attention.

Statistics from Shanghai and South China's Guangdong Province, respective hubs of the two deltas, show that the growth rate on most of the key indices, such as gross domestic product (GDP), industrial added value and fixed asset investment, all went down compared with the same period last year.

The GDP growth of Shanghai, for example, was 10.3 per cent in the first half of this year, 4.5 percentage points lower compared with the same period last year. In the same period, the growth of fixed asset investment in Guangdong slumped by 9.7 percentage points from the same period last year.

The downturn shows that the two regions are facing growth bottlenecks. Behind the weakening economy is the fallout from China's primary economic growth mode, growth driven by capital investment. It has restrained the further development of the country's economy.

To achieve sustainable growth, China needs to shift the focus from quantity to quality of economic growth and accelerate industrial upgrading and restructuring.

In terms of inflation, the prospects for high inflation are still there despite the 2.3 per cent consumer price index (CPI) growth released for the first half of this year.

The rate is 1.3 percentage points lower than last year's figure and is at a moderate level. However, the public anticipation of inflation remains high, because many people hold the view that the fast economic growth is yet to be effectively restrained, and the supply of coal, electricity, oil and transport is still falling short of demand.

Besides, real estate prices have kept rising steadily.

However, the analysis of the situation is complicated by the fact that the existing CPI index calculation system is seriously flawed.

In the current CPI calculation system, food prices take 34 per cent of the overall weight, non-food prices take 22 per cent, and service prices occupy the remaining 44 per cent. The weight of housing, education and medical expenditures counts for only a small part of the system, something that goes against the reality of the average Chinese consumers, who are increasingly spending more money in these three areas.

The CPI index, therefore, risks being underestimated.

Besides, since food prices form a large proportion of the CPI calculation, possible fluctuations in grain prices may push up the CPI figure as market conditions change.

In the first half of this year, farmers have seen a bumper harvest and the State began a large-scale sale of stored grain. As a result, supply has increased and prices have dropped, which constitutes a major reason for the decline in CPI level.

But it is hard for a country to maintain an abundant supply of grain over a long period of time, and if supply drops, grain prices will go up, pushing up the CPI index.

Increasing unemployment is another challenge facing the national economy.

Although statistics show that the country's employment targets of the first half of this year have been achieved, with the registered unemployment rate roughly at a par with that of last year, it is worth noting that the economic growth is creating less jobs than it used to.

In the 1980s, every percentage point of GDP growth led to 0.32 percentage points in employment growth. That figure is now reduced to about 0.1 percentage points.

Although the official unemployment rate is 4.2 per cent, some economists hold that since it is "registered unemployment rate" and does not take into account "unregistered" unemployed people, the real rate could be much higher.

Analyzing the structure of China's labour market, we find that farmers-turned-workers and high-calibre skilled workers are in short supply in the cities.

More seriously, new college graduates are finding it hard to secure jobs. The market can only provide 1.5 million jobs every year, far short of the demands of the 4 million college graduates.

On the financial front, the imbalance in China's international payments will pose challenges for the central bank's monetary policy manoeuvres, and affect the country's macroeconomic regulation.

China's foreign exchange reserves are expected to increase by more than US$20 million this year. And its trade surplus was US$39.65 billion by the end of June, compared with a registered trade deficit of US$6.82 billion at the same time last year.

The huge current account surplus reflects the immaturity of China's financial system. In China, the surplus means a high savings rate and a low investment rate. An important reason is that investors cannot find a proper channel to make investments.

In addition, the uncertainty of China's financial reform will increase if the country cannot properly handle issues such as renminbi revaluation, credit tightening, increasing deposit-loan gaps in the banks, rising non-performing loans and reform in the formation of the foreign exchange rate.

As banks tighten credit, the gap between bank deposits and loans is growing wider. Meanwhile, the amount of non-performing loans is expanding.

According to a report by the Chinese Academy of Social Sciences, the major State-run commercial banks saw their bad loans decrease by 394.6 billion yuan (US$48.7 billion). But we should not ignore the fact that the government poured US$45 billion into the Bank of China and the China Construction Bank in 2003 and pared off 270 billion yuan (US$33.3 billion) from the two banks last year to support their listing efforts. A portion of the bad assets of the Bank of Communications was also cut in its corporate restructuring.

If those figures are taken into consideration, the banks' bad loans surplus last year did not drop, but rise by 81 billion yuan (US$10 billion).

The scenario reflected by the money supply also merits caution. The surplus of narrow measurement of money supply, or M1, which includes cash in circulation and institutional demand deposits, by the end of June increased by 11.3 per cent, 4.9 percentage points lower than the same period last year.

This means the Chinese economy may become weak. It also indicates the banks' unwillingness to lend and the corporations' aversion to borrowing.

All this indicates a weakening investment mood.

(China Daily August 10, 2005)