By staff reporter Zhang Hong

While “change” has become a watchword for politics in Washington, change is just as much needed in China, especially as the economy is bids farewell to years of double-digit growth.

“It’s been high time for China to change its mode of economic growth and put more weight on the domestic demand,” said Shen Minggao, Caijing’s chief economist. “Otherwise we might have to pay the cost of a major economic backlash.”

Last week the National Statistics Bureau said the GDP grew nine percent year-on-year in the third quarter, the slowest pace of expansion for China’s economy since 2004. It’s clear to even the casual observer that China’s cooling export industry is a major factor reining in growth.

Recent remarks from the State Council signaled that the policymakers have switched their concerns from inflation to growth. China’s central bank followed major central banks around the world by cutting its benchmark rate by 50 base points on October 8. This move is likely the first of more policies to come, ranging from fiscal stimulus to credit and foreign trade supports.

However, these kinds of measure are patterned largely on traditional methods of stabilizing exports and encouraging investment. China has repeatedly relied on these tactics before, assuming external demand would increase simultaneously. But the trick might not work this time, as the financial crisis in the U.S. has yet to see the light at the end of the tunnel. Worse, over investment now could lead to excessive capacity or even deflation.

That said, stimulating consumption seems to be the only safe road. The government last week announced it would raise grain prices, which is expected to increase farmers’ income and thus their willingness to spend. But this is far from enough to successfully transform China’s tenacious pattern of domestic demand, an “invest-rather-than-consume” addiction.

One of the reasons why Chinese households have been reluctant to spend is that they earn little, explains Shen. The economy has leaned on the public sector, as state government and state-own enterprises play a major role in investment. “In parallel, the state has to impose price control to protect consumers, because the proportion of household income in the economy is declining,” Shen said.

China has been able to maintain rapid growth despite low private spending thanks to growing external demand. As a result, it has accumulated a huge foreign exchange reserve that cushions China against external shocks and keeps the yuan from appreciating.

As a way to hold the reserves, China has bought great amounts of treasuries from the U.S. and other countries. “Essentially, China lends to other countries for buying its cheap commodities,” Shen put it. “This is a dangerous game.”

In order to change this pattern, China needs to shift part of the risk shouldered by the state to the private sector, and thus enable the latter to achieve higher gains. To do this, Shen proposed privatizing the foreign reserves, developing bond markets, and further facilitate market access for the private sector.

By relocating part of the official reserves to the private sector, the state could eschew some of the risk that holding U.S. assets entails, while private households and companies could simultaneously diversify their portfolio by investing overseas. But none of this will be possible before the yuan becomes free to convert.

Current conditions present a opportunity for China to derestrict the yuan, since the long-held believe that the yuan will appreciate against the U.S. dollar reflects less and less the actual situation. While in the short term, this rate might undulate; in the long run, the yuan is likely to strengthen against other major currencies. A stronger yuan would encourage companies to focus more on the domestic market by increasing supply and thus creating demand. Meanwhile, consumers would be able to buy more foreign products with their salaries.

Another key step toward reform is widening access to finance for the private sector, particularly by opening up bond markets for private firms. China’s corporate bonds amount no more than 4 percent of stock market capitalization, mostly issued by state-owned enterprises.

Foreign investors should also be approved for issuance of yuan-denominated bonds, as they might borrow yuan and buy dollar to broaden their investments. In this way foreign companies would also share China’s risk of holding foreign exchange reserves.