As the growth of GDP slows down China may run into deflation in 2007 and 2008, but will not be lost in deflation as Japan experienced during the 1990s, said Dr. Stephen Green, a senior economist with the Standard Chartered Bank.

China's weak banking system and an aging, saving-inclined population are all similar to what happened in Japan during the 1980s, said the British economist, but the deflation risk can be avoided if proper policies are adopted.

Mr. Green believes that three key factors will contribute to protect China from the same problems of Japan:

First, China's exchange rate policy can save the country from sharp RMB revaluation. The Chinese currency has risen over 2 percent against US dollar since July 21, and would go beyond 3 percent in the coming three years. The revaluation will not be as huge as Japanese yen even considering the estimation of 5-10 percent by some analysts.

Second, Chinese banks will continue lending business. Although bad loans may keep rising, China's commercial banks are still controlled by the government. The crash of Japan's monetary transmission mechanism had made its central bank unable to intervene loan lending efficiently. But this will not be the case in China. Besides, China is still a developing economy that provides many profitable opportunities for investment.

Third, there is no major asset bubble in China. Japan's economic crisis was triggered by the burst of asset bubble, but China has a tradable capital of nearly 200 billion US dollars on its stock market, taking about 12 percent of GDP. The stock market has been at a low ebb in recent years, and although a real estate bubble appeared in some areas, it didn't spread nationwide as the central government took financial and administrative measures in last April to check it.

Mr. Green also gave four policy suggestions to avoid deflation: first, managing the exchange rate sensibly. Gradual and measured RMB revaluation, such as 2-3 percent a year, will not harm the growth of export, but will prompt exporters into sectors of bigger value. Second, taking great care with liberalizing capital flows. It is correct to prevent the inflow of short-term funds, while the best way to do it is to make it harder for them to flow out of China. Third, liberalizing interest rates carefully, and tapping other non-bank financing channels. Fourth, targeting moderate inflation.

By People's Daily Online