As the impact of the international financial and economic turmoil on China's economy is expected to intensify, China's domestic economy and the government's stimulus policies are key, according to the World Bank's latest China Quarterly Update released on Tuesday.

The impact of the crisis is spreading globally, with risk aversion and deleveraging leading to a funding squeeze that affects demand in many countries. This includes many emerging markets that, as a group, buy more than 50 percent of China's exports and until recently continued to see strong import growth. The update expects that, as in earlier global downturns, China's export growth is likely to be low in 2009, even with expected continued market share gains reflecting China's strong competitiveness.

Domestic factors have already made China's economy slow down in 2008, coming off its high pace in 2007. Weakness in the real estate market, due in large part to an earlier tightening in macroeconomic policies, have fed through to several "upstream" industries. Looking ahead, private sector investment is likely to be weighed down by the unfavorable external prospects and continued weakness in real estate. Private consumption growth is likely to soften in 2009, but will receive some support from fiscal policy.

In the mean time, inflation is coming down steadily. After absorbing higher food prices, headline inflation has receded and, with sharply lower raw commodity prices, inflation is not an issue of concern at this point.

Against this background, the authorities have adopted a more expansionary macro economic stance, and higher government-influenced spending is going to play a key role in 2009. Since the summer of 2008, the authorities have taken several steps to support growth.

"This culminated in November with a ten point plan to stimulate domestic demand and growth," says David Dollar, World Bank Country Director for China, who welcomed the plan. "The emphasis will be on accelerating and increasing infrastructure and other investment, but of a different nature than in the wake of the Asian crisis, with many projects focusing on broad long term development and improving living standards."

The report's main author, senior economist Louis Kuijs added that most of the ten elements mean higher direct government-influenced spending -- in the form of investment or consumption -- and should thus have a measurable impact on output in the short term. "Our forecast for 2009, which sees GDP growth of around 7.5 percent, has more than half of that coming from government-influenced spending."

The update finds that the stimulus policies provide China with a good opportunity to rebalance its economy in line with the objectives of the 11th five-year plan. The stimulus package contains many elements that support China's overall long term development and improve people's living standards. Some of the stimulus measures give some support to the rebalancing of the pattern of growth from investment, exports, and industry to consumption and services. The government can use the opportunity of the fiscal stimulus package to take more rebalancing measures, including on energy and resource pricing; health, education, and the social safety net; financial sector reform; and institutional reforms.

(China Development Gateway November 25, 2008)