The impact of the global financial crisis is spreading, the report says, 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.
"In terms of the effect of China's slowdown on the world, there's good news and bad news," said David Dollar, World Bank Country Director for China. "China's recently announced stimulus package is good news because it will keep China's growth rate up at a pretty healthy rate and so imports will continue to go into China at a fairly good rate. That's good news for countries like Mongolia and Australia that export commodities like copper and iron ore to China – it's also welcome news for countries selling primary products, machinery and parts to China. The bad news is there won't be as much stimulus to these exporting economies as China was giving in the past."
The report analyzes some of the domestic factors that have already made China's economy slow down in 2008 compared to the high pace of 2007. Weakness in the real estate market, partly reflecting an earlier tightening in macroeconomic policies, is now feeding through to several “upstream” industries such as cement and steel. 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.
At the same time, the report says inflation is coming down steadily. After absorbing higher food and energy prices, headline inflation has receded and, with sharply lower raw commodity prices, inflation is not a concern at this point.
With prospects for growth and inflation changed rapidly, the Government's more expansionary macroeconomic stance and higher government-influenced spending is going to play a key role in 2009.
"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," said David Dollar.
"We're encouraging China to look to a new growth model that depends more on domestic demand and domestic needs," said David Dollar. " So, as China builds infrastructure as part of the stimulus package we're hoping it's focusing on infrastructure that addresses future needs such as energy efficiency, urban public transport and high speed rail."
The report's main author, senior economist Louis Kuijs, added that most of the recently announced ten points for stimulating domestic demand and growth mean higher direct government-influenced spending - in the form of investment or consumption - and should therefore have a measurable impact on output in the short term. " More than half of our GDP growth forecast of around 7.5 percent for 2009 is 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 Program. 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.
