Can China Rescue Its Economy?

On Wednesday, HSBC roiled markets around the world by releasing its Flash China Purchasing Managers� Index for November.� The widely followed indicator dropped from 51.0 to 48.1, crossing the crucial line of 50 that divides expansion from contraction.� Most worrisome, it appears that the factory sector is shrinking due to weakness in domestic, as opposed to export, orders.

The drop in the HSBC Index, which normally moves only tenths of a point at a time, is just another sign that the world�s second-largest economy is contracting from one month to the next.� The troubling news follows October numbers, which also pointed toward a rapid falloff.� There was, for instance, a sharp decline in inflation, collapsing real estate prices, and a big decrease in bellwether car sales.� The wheels are coming off the Chinese economy, with indicators dropping faster than virtually all analysts�including me�predicted.

Chinese technocrats have already started to react, applying monetary measures.� The People�s Bank of China, the central bank, this month cut its required reserve ratio for 20 co-operative banks to 16.0%, a reduction of a half point.� Officials maintained that this move did not represent a change in their tightening policy, but, as Tom Holland of the South China Morning Post points out, the denial �stretches credulity.�� PBOC watchers, therefore, see the limited relaxation as a hint that the institution will soon cut reserve requirements, now at historic highs, for all banks.

Moreover, Wang Qishan gave a tantalizing indication of an overall change of policy last Monday.� �An unbalanced recovery would be better than a balanced recession,� the vice premier said to his American counterparts at the 22^nd session of the Joint Commission on Commerce and Trade in Chengdu.

Wang�s meaning was not entirely clear, at least from his published comments.� Chinese officials in Chengdu did not say they would try to promote exports, although they did th! at in th e Asian Financial Crisis at the end of the 1990s and again in the 2008 downturn.� Indeed, many now predict that Beijing will stop the general appreciation of the renminbi precisely for this purpose.

Moreover, Beijing is bound to go back to pump-priming tactics. �At the same time the vice premier spoke about further unbalancing the Chinese economy, Beijing�s technocrats began talking about their goal, incorporated in the ongoing 12^th Five-Year Plan, to spend $1.7 trillion on green and high-tech sectors.

Beijing has been consistently successful in creating growth during times of external crisis.� But will its plans work this time?

The favorable outcome from the Asian Financial Crisis is not applicable to today�s situation.� Then, demand throughout the developed world was robust.� Today, however, European orders have dropped dramatically.� Moreover, American consumers�still the engine of global growth�appear to be tapped out, despite their record-shattering exuberance on Black Friday.

Furthermore, the international community is much less tolerant of Beijing�s mercantilism these days, as evidenced by China�s exclusion from the Trans-Pacific Partnership negotiations in Honolulu this month.� And if the world tumbles into a second downturn, as increasingly distressing events from Europe suggest, exports will not be making a significant contribution to China�s growth.

Beijing, therefore, will need to resort to monetary and fiscal tools to restart the domestic economy.� In view of the recent monetary tightening, there is room for easing.� Yet the PBOC cannot lower benchmark interest rates�the most effective monetary tool�because that would undoubtedly trigger an outflow of deposits from the commercial banks. �Deposit rates are already well below inflation, so Beijing does not have much flexibility.