As the US financial crisis starts to take its toll across the globe, China is set to reverse its monetary policy stance from the previous tightening cycle to ward off a potential economic downturn, analysts said.

In response to the worsening financial crisis, the US government has taken a slew of measures to unfreeze credit markets and bail out beleaguered financial institutions, including the US$700 billion rescue plan. The European Union, Japan and other major economies have followed suit.

"While all the developed economies are pondering how to rescue their economies, we expect that China will make further interest rate adjustments to help it offset the repercussions from ailing Western economies," said Kang Yan, a partner at Roland Berger Strategy Consultancy.

In the first three quarters of this year, China's GDP growth was 9.9 percent year-on-year, 2.3 percentage points lower than the same period last year, which was considered by many as a signal of a downside spiral.

The State Council has vowed to tackle the danger of economic hard landing by making major policy changes.

"As the global economy is deteriorating, we should adopt flexible and prudent macroeconomic policies to stabilize the domestic financial market and promote steady and rapid economic growth," Li Xiaochao, spokesman of the National Bureau of Statistics, said yesterday.

A major change would come on the monetary front, analysts said. China has cut both interest rates and the reserve requirement ratio twice within a month, which can be taken as a signal that the government is loosening its monetary policy.

"If the global financial turmoil spills over to the Chinese economy, the government will take further measures," said a macroeconomic analyst with Changsheng Fund Management Company. "We may see another 100 to 160 basis points cut in interest rates in the future (before economic growth can stabilize)," said the analyst, who wished to remain anonymous.

However, analysts commonly believe that a more relaxed monetary policy alone would not be enough to invigorate the economy.

"We expect the government to also come up with proactive fiscal policies to ward off the danger of economic hard landing," said Kang from Roland Berger.

Along with interest rate cuts this month, the 5 percent personal income tax on savings interest was also scrapped to stimulate domestic demand, which offsets depositors' losses from recent deposit rates cuts.

"It is more like a gesture than a substantial move, but it indicates that more favorable fiscal policies may be in the pipeline," said the analyst from Changsheng Fund Management.

Policymakers have a number of options including increasing infrastructure investment, reforming the value-added tax system and cutting personal income tax, the analyst said.

The recently concluded 3rd Plenary Session of the 17th Central Committee of the Communist Party of China flagged up rural development as the top priority and vowed to double farmers' incomes by 2020.

Analysts said more capital may hopefully be pumped into infrastructure construction in the vast rural market, which will substantially boost domestic demand among rural residents in the coming years, when the national economy may see its exports, one of its major growth pillars, continue to fall.

"China's rural areas with a population of more than 700 million people would constitute a strong driving force for the country's economic development," Kang said.

Another potential move is value-added tax (VAT) reform, which was initiated in northeastern China on a trial basis in 2004. Unlike the current system, the reform would allow the deduction of input VAT incurred on fixed asset purchases, thus encouraging corporate investment in equipment renovation.

Economists expect the reform to start from next year, as more and more enterprises start to feel the pinch due to rising costs and decreasing demand from the gloomy international market.

According to a China International Capital Corporation (CICC) report published last Tuesday, the reform would lead to a tax reduction of 150-200 billion yuan.

As the economy is facing growing downside risks, analysts are also expecting the threshold for personal income tax to be raised to stimulate domestic consumption. The CICC report said the threshold would be raised from 2,000 yuan to 3,000-4,000 yuan, which will be equal to a tax cut of 50-80 billion yuan.

But the stance of the taxation authorities, who may worry about a sharp decline in tax revenue, would be crucial to whether those reforms will be carried out soon, analysts said.

(China Daily October 21, 2008)