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COVER STORY: China's Economic Challenge

Elaine Wu January 01, 2009

Since first embarking on market reforms in 1978, China has witnessed an era of unparalleled growth and development, lifting millions of its citizens out of poverty. For the past 30 years, China's economy has expanded at an annual average rate of 10 percent, challenging all traditional theories of how fast developing nations could grow and how long such rapid growth could be sustained.

But it seems that China's days of double-digit growth are on hold for the time being, and any debate over whether a country with US$2 trillion in foreign reserves and a deep pool of savings could withstand the fallout from the global financial crisis has ended. Plunging exports, slumping real estate and growing unemployment are hallmarks of an economy that is slowing down significantly from three decades of historic economic growth.

China's economic forecast for 2009 is clearly more restrained than in years past, as its gross domestic product (GDP) growth has begun to slow. The country's industrial output growth, a closely monitored economic indicator, dropped 3.2 percent in November from October to its lowest pace in almost a decade.

According to government statistics, exports also shrank for the first time in more than seven years, falling 2.2 percent year-on-year in November. Imports to China fell even more sharply – down 17.9% in November compared to 2007. China's Purchasing Managers' Index (PMI), a gauge of performance in the manufacturing industry, dropped to a record low of 38.8 points in November from 44.6 points in October, a further reflection of the slowing economy.

Foreign direct investment in China also fell 36.5 percent in November from 2007, to US$5.3 billion. U.S. companies on the ground in China have been affected as well. Nearly 75 percent of companies in the American Chamber of Commerce in Shanghai's 2008 China Business Report noted that global economic conditions were negatively impacting their China operations.

These numbers present a sobering picture for an economy that has been fueled by exports and foreign investment for the past 20 years. According to official statistics, exports make up roughly 40 percent of the country's GDP. As slumping import figures indicate weakening domestic demand and greater consumer and business risk aversion, economists expect China's GDP growth to fall even further from the estimated 9.4 percent for 2008.

Recently, the World Bank cut its 2009 GDP growth forecast from 9.2 percent to 7.5 percent, while Goldman Sachs further revised its forecast from 7.5 percent to 6 percent, a startling drop from China's 11.9% growth in 2007.

"The numbers are coming down very sharply," says Michael Pettis, professor of finance at the Guanghua School of Management at Beijing University. "There has been a wide range of forecasts, but I think that whatever the numbers are going to be, they are going to have to be revised downwards."

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