Domestic Demand in Dire Need of Policy Stimulus

China’s economic growth rate for the second quarter hit below 8% for the first time during the recent three years. The prospect for economic growth will be less optimistic for a future period of time. Policy priorities of stabilizing the economic growth still rest on stimulation of domestic demands， and breakthroughs are waiting to be made in the adjustment of financial policies.

It still needs further observation to see whether the economy will rebound from an all-time low. A broad set of data indicates that the growth of domestic demands remains slow and fragile. The credit loan data also shows that in June about RMB 900 billion new loans went into the market， but the corporate long-term loan only accounts for 17% of the total， showing a low demand for investment.

The growth rate of investments on infrastructural construction has turned from negative to positive on year-on-year basis， but the growth rate for the first half year is as low as 4.4%， with the prospect for further growth still uncertain. Both of the import and domestic consumption have slumped in June， showing a fragile recovery of domestic demand.

In such a circumstance in which both foreign and domestic demands are sluggish， tremendous tasks to stabilize the economic growth will be ahead of China. It is important to explore the long-term growth potential， adjust the economic structure， and stimulate the domestic demands， to give more priority to the economic growth stability.

With the positive financial policy as the basis， breakthrough shall be made in the strength and measures of policy adjustment. China should make good use of the reform of income distribution system， reduce the tax and create more revenue to stimulate the domestic demands.

The first is to reduce tax. Data in the first half year shows that as the economic growth rate declines， the increase of financial revenue also slows down. In the economic transformation period， tax reduction will play an irreplaceable role in the adjustment of economic structure， with its impact and efficiency larger than the boosting of public expenditure.

Therefore， although the structural tax reduction overlaps with the economic slowdown， it is necessary to create a long-standing mechanism for economic stability and growth at the expense of shrinking financial revenue.

Increase more experiment units of “changing business tax to value-added tax”. The original aim is to realize fullcoverage of “changing business tax to value-added tax” during the “12th Five-Year period”， and China should speed up the process to coordinate with the macroeconomic policy of stabilizing growth and adjusting structure. The experiment of“changing business tax to value-added tax” has been implemented in Shanghai for half a year， and more local governments will get involved into such a reform.

Data shows that if such tax reform is finished， the tax burden on companies will be relieved by more than 100 billion yuan. A further reduction of value-added tax rate will be more conducive to the development of emerging industries.

China shall further relax the entry threshold for small and medium-sized companies. The Ministry of Finance and State General Tax Administration have recently announced that during January 1， 2012 to December 31， 2015， for small companies with annual taxable income lower than 60，000(including 60，000)， the 50% of the income will be included into the taxable income， and the corporate income tax rate will be 20%.

The threshold of business tax and value-added tax has also been uplifted. Experts say that it is necessary to further such favorable tax policy to bring more benefits to those small and medium-sized companies.

The second is to stimulate consumption. China shall accelerate the pace of income distribution reform and work out applicable solutions. China shall first optimize the tax structure， to enhance the role played by tax in income adjust- ment. Because the indirect tax constitutes the bulk of China’s tax varieties， most laborers have to shoulder heavier taxes.

What’s more， China shall increase the public expenditure on people’s welfare and enhance the redistribution effect of transfer payment. Also， public expenditures on medical health， education and household shall increase. China shall improve the social protection and establish a social protection system with equal opportunity and benefit for every citizen of the country. China will also provide public services to the low-income population.

The third is about increasing financial support through targeted loans. Some commercial banks feel uncomfortable about the impact on fixed asset investment from the adjustment of real estate policy measures. Therefore， shrink of loan demands and decrease of long-term loans happen.

As a matter of fact， a lot of real demands for loan still exist in emerging industries， small and medium-sized companies and areas like municipal facility construction and maintenance and energy which are supported by the national government. China shall adopt proper measures to direct and encourage loan capital to be invested into these fields.

Besides， as the complimentary policy， the Central Bank is estimated to use a set of currency policy tools to fine-tune the financial policies， such as lowering the deposit reserve ratio， using differentiated deposit reserve ratio， or use targeted buy-back measures to raise inter-bank market liquidity， to meet development demands of the real economy. There is still space for lowering the interest rate in the second half year and China could continue to increase the floating range of loan rate.