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The growth of the Chinese economy over the past couple of decades has been spectacular, driven by internal reform and external demand. The country appeared to be on a seemingly endless growth trajectory with many commentators suggesting growth would continue at a stupendous pace, despite the global slowdown..

Recent data, however, indicates China has not decoupled from global weakness and is slowing quickly. Exports declined sharply by 17.5 per cent year-on-year in January, and real estate investment has fallen off a cliff. GDP growth has slipped to 6.8 per cent in the fourth quarter of 2008, a very low figure by recent Chinese standards. Unemployment has risen steeply as factories have closed in southern China. Layoffs have sparked protests by workers, raising the spectre of a period of sustained social unrest.

In response, the Chinese government has announced a series of measures to stimulate the economy. Interest rates have been cut and reserve requirements for the banking sector reduced. Many of the austerity measures imposed to cool the property sector have been rolled back in recent months.

Most significantly, a substantial stimulus package has been announced. This is worth 4trn renminbi (£392bn) over the next two years. The investment package, which is scheduled to be spent before the end of 2010, is focused on key areas of the economy such as transport infrastructure, rural electricity and gas facilities, low-rent housing, agricultural subsidies and minimum income support. It will be used to rebuild communities devastated by the earthquake in Sichuan province in May 2007, which killed an estimated 70,000 people and left millions homeless. The government has also indicated it will provide further measures to boost domestic consumption.

The Chinese government is in a very fortunate position compared to western governments as debt as a per cent of GDP is very low – roughly 30 per cent – and there is an ocean of savings in the Chinese banking system (about 150 per cent of GDP). The country has also accumulated vast foreign exchange reserves over the past decade, which reached $1,946bn (£1,307bn) in December 2008. The Chinese Communist Party has been described by one commentator as the “world’s most liquid financial institution.”

First, let us consider the urban setting. Various short-term measures, such as tax rebates, primarily benefiting sectors of the economy with low value-added products or facing overcapacity, such as textiles, have been announced. Although in the recent past the government’s strategy has been to move Chinese manufacturing up the value-added ladder, this short-term policy is concerned with keeping people in work. Low value-added industries would have been left to market forces if it had not been for the current financial crisis.

Consumption coupons have been issued in certain cities by local governments to low-income residents over the Chinese New Year holiday. For example, Chengdu, the capital of Sichuan province, has issued vouchers worth 100 renminbi to 380,000 low-income local residents. This may be a more effective means of boosting consumption than income tax cuts, which might only encourage more saving.

In total, lump sum grants have been made by the ministries of finance and civil affairs totalling $1.42bn to 74m people. The pension benefits of state-owned enterprise retirees have been increased by 10 per cent. The salaries of 12m teachers have been raised to the level of civil servants. The government is halving the purchase tax on vehicles with engines under 1.6 litres cubic capacity to boost sales of more environmentally friendly vehicles. There is also a stimulus package for the high-tech, IT and environmental industries.

The government has not just focused its efforts on the cities. The rural economy is still very important for the country, despite the urbanisation trend of the past few decades, as agriculture accounts for about 44 per cent of total Chinese jobs.

The government has announced subsidised sales of household appliances and electronics products to rural residents, and a 13 per cent rebate for purchasing goods, including TVs, refrigerators, mobile phones and washing machines. However, the rebates only apply to products below a certain value and will not boost demand for high-end items. A similar scheme should follow to encourage lightweight vehicle sales in rural areas.

Other rural-focused policies include providing farmers with higher grain procurement prices, which will boost incomes, as well as direct subsidies on fertilisers.

Long-term measures focused on the rural environment aim to improve rural disposable income. The government has reiterated its commitment to land reform, which would allow transfer of land rights over the long term. At the moment, rural land is still ‘collectively’ owned, although it may be leased to peasants on 30-year contracts.

The extension of peasant ownership rights should begin a process of land consolidation and allow further improvements in agricultural productivity.

The Chinese government is, therefore, committed to a substantial, broad-based stimulus to many areas of the economy. However, some of the above measures are not consistent with each other. For example, protecting low value-added export industries is at odds with the long-term objectives of upgrading the structure of domestic industry and protecting the environment. But from the government’s point of view it may be the best way of maintaining social stability in the short term until the global economy returns to growth.

The various stimulus measures also require substantial funding. The government does have flexibility, but should the current global economic slowdown continue much longer than expected, it could find it more difficult to continue to fund all these areas from a finite pool of resources. There are also concerns the significant rebound in bank-loan growth that has occurred over the last couple of months, driven by directed lending, could create more unproductive capacity and an escalation of bad debts.

Nevertheless, China remains in a relatively healthy position to intervene in its economy and limit the impact of the global slowdown. The response to the present global crisis will hasten the reform process in some areas of the economy and delay it in others. Economic policies over the past 30 years have often been fine-tuned to serve new developments. But the transformation of the Chinese economy is an ongoing long-term process.

We are likely to see more structural growth opportunities in areas such as consumer goods, environmental, new energy, agricultural and technology.

Quanqiang Xian is a senior portfolio manager at First State Investments