Ahead of the National People's Congress (NPC) and Chinese People's Political Consultative Conference (CPPCC) meetings in Beijing this week, Premier Wen Jiabao announced that China's GDP growth target will be lowered to 7 percent from the previous 7.5 percent set in the 12th Five-Year Plan.

The impact of this announcement is yet to be seen but a lower GDP target may in fact be beneficial to the development of the country. At the NPC meeting, Premier Wen also stressed that controlling inflation was his first priority using four initiatives to combat this: 1) monetary tightening to control liquidity, 2) boosting the supply of agricultural products, 3) improving distribution efficiency, and 4) cracking down on market speculation.

Lowering the GDP target to 7 percent will benefit China for several reasons. First, the current level of growth at 10 percent or slightly above is not sustainable for extended periods. This could lead to a misallocation of resources with excess liquidity flowing to inappropriate sectors - ultimately leading to overheating and further inflationary pressure.

China's GDP growth for the past two to three years has been driven mainly by government spending. But these high growth rates spurred on by the government are not sustainable. Therefore, a more balanced and sustainable level of growth in China needs to be achieved through stronger domestic consumption. Combining this with further monetary tightening and inflationary pressure may ease to a more desirable level.

As the central government increases its Reserve Requirement Ratio (RRR) and interest rates, the ultimate goal should be to have rates near inflation expectations. Analysts estimate an additional 100 basis points (bps) rate hike in 2011 with the next 25 bps coming in March. The RRR is expected to increase to 22.0 percent (currently at 19.5 percent) in order to decrease money supply growth to approximately 16.0 percent. These tightening measures should help combat the increase in inflationary pressure.

In addition to having GDP growth less reliant on government spending, China needs to further support SMEs. A big factor for successful and stable economic growth will be these small and medium size enterprises. As they receive more loans and grow, SMEs will invest, spend and hire more. As unemployment is reduced, the concern for rural citizens to move to urban areas will calm as farms and other rural regions partake in the country's economic prosperity.

If the central government successfully spurs SME growth, then employment will rise along with wages and domestic unease over these issues should lessen. More people with jobs and higher wages will thus spend more domestically - and rising prices will therefore also be more affordable. In addition inflation will be pushed through demand rather than costs. In other words, prices will rise because of consumer demand and spending ability instead of rising commodities prices and other costs. The growth of SMEs will lead to a more balanced and consumer driven GDP growth.

Stable growth in the labor force is the blueprint for healthy GDP growth. This will raise the consumption part of GDP from current levels of around 37 percent of GDP to above 40 percent. Having higher consumption contributing to GDP growth will offset lower net exports due to increasing appreciation of the yuan.

In the end, Premier Wen was right in lowering GDP targets. With this announcement, the central government will now be able to better control overheated asset prices, leading to more stable and balanced economic growth.

The author is a visiting professor at the Asian International Open University, an international financial commentator at NOW business news channel and founder of www.wongsir.com.hk.

(HK Edition 03/11/2011 page2)