Slower growth and increasing inflationary pressures mean China needs economic restructuring to ensure healthy development

The Chinese economy has arrived at a crucial stage of all-round structural adjustment. In the coming two or three years, companies will start to feel the pressure as economic growth will continue to slow and there is likely to be moderate inflation of between 3 to 5 percent. Given this, it is essential that the country presses ahead with structural reforms.

China does not need to worry about a hard landing of its economy, because with its average per capita GDP only $4,000 the economy still has lots of room to grow. China is a big economic power with an extremely large domestic market. Its relatively poor and underdeveloped west, for instance, can take over production capacity from the east, and digest much of the excessive production capacity now haunting the national economy as a whole.

A basic feature of the Chinese economy today is the excess production capacity, especially in the manufacturing sector, and the inadequacy of effective demand. Under such circumstances, Chinese manufacturers should be able to find ways to digest the pressure of rising costs even if prices of raw materials rocket. So the Chinese economy will continue to grow for quite a long period of time.

There are also three factors that provide a solid foundation for economic growth: urbanization; massive land development, which is closely related to urbanization, such as the construction of water conservancy and anti-seismic facilities and projects for the prevention and control of other natural disasters; and the expansion of consumption.

But although the Chinese economy will not experience a hard landing, it is crucial that it undergo structural adjustment.

While the Chinese economy has maintained its high-speed growth during the past decade, especially since China adopted a stimulus package to combat the financial crisis, some fundamental issues besetting its economic development have become all the more evident and they urgently need addressing. The most pressing being the reliance of local governments on land-sales-based financing, which is both unsustainable and potentially risky. Ch

The slowdown of economic growth and the increase in inflationary pressures are both forces spurring China's economic restructuring and the effects of this restructuring are desperately needed.

A major factor causing economic growth to slow is the weakening investment impulse, a situation that can be directly blamed on changes in the investment sources accessible to local governments and the subsequent decrease in their investments.

The growing cost pressures on enterprises is another factor slowing growth. Wages have continued to rise and the prices of raw materials are going up day by day, eroding the low-cost advantage enjoyed by Chinese enterprises over the past decades.

Meanwhile, China will be unable to keep its inflation rate below 2 percent, as it did before the financial crisis, as major issuers of international currencies will continue their expansive monetary policies, driving up the prices of raw materials and increasing the flow of hot money into China. So moderate inflation of between 3-5 percent is likely in the next few years.

The relatively low rate of economic growth plus moderate inflation means some enterprises will start to feel the heat. Export-oriented enterprises, in particular, will find the going harder than before, and no doubt some will go bankrupt during this process. But the structural changes would create a healthy environment for those able to adapt.

Government policies will undoubtedly play a vital role during this period of economic restructuring and it is imperative the country presses ahead with reforms, including adjustment of the central and local tax structure, implementation of structural tax reduction, advancement of the reform of State-owned enterprises, and increasing the ratio of direct financing.

The coming two to three years are of vital importance to China's continuing economic growth and there are enormous challenges to overcome. But if we can seize this opportunity, our economy will secure a solid foundation for lasting healthy development in the future.

The author is chair professor with the School of Economics and Management under Tsinghua University and distinguished professor with the Changjiang Scholars Program.