America’s subprime financial crisis and the resultant dramatic global downturn after the Lehman Brothers fiasco hit the Chinese economy staggeringly. Following the sudden free-fall of the global economy, growth of the Chinese economy fell to 6.8% in the fourth quarter of 2008, down from 13% in 2007. Parallel to this was the imminent threat of deflation, contrary to the usual inflationary pressure that had pestered previous Chinese economies.
Clearly, the four main channels whereby the global financial crisis impacted the Chinese economy was:
– Direct losses in American capital market
– Changes in cross – border capital flows
– Reduction in growth of exports
– Safety of foreign exchange reserves.
Now, the Chinese government were forced into a prompt reaction to this sudden plummet. In November 2008, a 4 trillion yuan stimulus package was introduced. Acting in tandem, the central bank, the People’s Bank of China (PBOC) cut interest rates deeply, and the growth rate of credit and of broad money shot up. It seems that the economy started bottoming out as early as in the first quarter of 2009, owing to the stimulus package and the extremely accommodating monetary policy.
Focusing predominantly on this Stimulus Package which equated to 16% of the Chinese GDP, you can see the explicit spending breakdown here – Infrastructure: 45%, Post Earthquake Reconstruction: 25%, Rural Infrastructure: 9%, Ecology: 9%, Housing for Low Income Population: 7%, Technological innovation and Economic Re-structuring: 4% and Medical Services, Culture and Education: 1%.
You can see clearly how the majority of this package was spent on infrastructure such as railways and highways with 1800 billion yuan spent on ‘expenditures in transportation network and construction. One would assume this was a deliberate ploy by the Beijing Government in order to get the ‘country running again’. Highways, railways are essential for transport in China exacerbated by its huge size. This can be seen currently by the money being poured in to the building of the Bullet Train Network. Furthermore, vast amounts of money was spent on the construction of highways et al because they provide jobs. Take the Bullet Train Network again – up to 10, 000 workers are employed on just one particular line of this rail network highlighting how the construction of these transport links can provide jobs which provide workers with capital which can then be spent in the local community. Therefore more money is pouring into the local economy as people are spending their earned money in the community eliciting economic growth etc.
Table 3. Breakdown of the 4 Trillion Yuan Stimulus Package
(billion yuan)
| Construction of houses for low-income urban households |
280 |
| Increased spending on rural infrastructure and boosting rural incomes |
370 |
| Expenditures in transportation network construction | 1800 |
| Increased investment in medical services, culture and education |
40 |
| Increased spending on ecological protection |
350 |
| Technical innovation and economic restructuring |
160 |
| Sichuan post-earthquake reconstruction | 1000 |
| Total | 4000 |
Source: NDRC.
The Economist, ‘The World in 2009’ China’s Stimulus Package, November 12th 2008. http://www.economist.com/blogs/theworldin2009/2008/11/chinas_stimulus_package
Yu Yongding, TWN Global Economy Series, The Impact of the Global Financial Crisis on the Chinese Economy and China’s Policy Responses, 2010.
Understanding Modern China 
For many years, China has been very much conservative in fiscal expansion. China’s
fiscal revenues as a share of GDP increased from 11 per cent in 1997 to 21 per cent
2007. In 2008, the ratio of fiscal deficit to GDP amounted to a mere 0.6%; the ratio of
public debt to GDP was only about 20%. Therefore, China has a very strong fiscal
position for implementing the stimulus package and even for enlarging its scale if
necessary. Similarly, China’s banking sector basically remains sound and healthy. The
average ratios of non-performing loans (NPL) for all commercial banks and
state-owned banks have been successfully reduced from 25% in 2002 to about 6% in
2008. The leverage ratio of the Chinese banks has been very low. The loan-to-deposit ratio in 2008 was only about 63%, lower than many emerging market economies. The
sound banking sector will provide more room for the possible deterioration of a loan
quality.
However, there are also some risks and problems. Firstly, much evidence indicates
that some of the new bank loans have been infused into the stock markets and
property markets. From November 2008 till July 2009, the Shanghai stock composite
index (A share) increased by 110 %, reaching 3300 points from 1600 points. Since
February 2009, the housing prices in some coastal cities have surged by 40% on
average. Obviously, the asset bubble problem has once again become a big concern
now. Since July, the authorities have decided to control the increase of bank credits,
which eventually caused the new bank lending shrinking to 355.9 billion Yuan in July
or a sharp fall by 77% from the latest peak amount in June. It is clear that the
monetary policy is facing a dilemma. If the authorities continue to control the bank
credits and even switches to moderately tight monetary policy, then many new
projects may suffer from shortage of expected new funding injection and eventually
become problem projects and the bank loans injected early may become
non-performing. If it gives up the efforts to control the crazy surge of bank loans, the
asset bubble may become very serious in the near future.
Secondly, the stimulus package might strengthen China’s reliance on the
investment-driven growth model if the money can not be used more correctly. Since
the late of 1980s, owing to the rapid the industrialization and urbanization and the
deep integration into the world production network after its access into WTO, China’s
economic growth has increasingly relied on the investment in industrial sectors.
Under such a growth model, China’s industrial sector has been much larger while the
service sector is much smaller, compared to the average level in the world (even in
developing world). By implementing the RMB 4 trillion fiscal stimulus packages,
China should have a good chance to make a better balance between the two sectors,
but it is also likely to make the structure more imbalanced in the future. As we
mentioned above, the spending on education, medical care, social security and other
modern service sectors are quite limited. It would be more helpful if the government
could finally increase the weights of the investment in these areas.
Thirdly, keeping Renminbi exchange rate relatively stable and restoring export
stimulating measures, such as increasing the tax rebate rates for some exports may
slow down the process of reducing the economy’s excessive reliance on external
demand. These policy responses are somehow necessary for eliminating the negative
external shocks. And keeping exchange rate stable is also helpful for improving the
effectiveness of fiscal expansion (McKinnon and others, 2010). But if these export
stimulating policies, as a short-term policy response, wrongly remain in the long run,
China’s structural adjustment may be delayed. Therefore, when the external shock
dissipates, it is necessary for the government to allow the Renminbi to appreciate
gradually in accord with the need of structural adjustment.
Finally but not least, it would be a big challenge for the central and local governments
to avoid mistakes in selecting investment projects at microeconomic level.
Accordingly, a rebound of nonperforming loan rate seems to be unavoidable. It is
really important to keep it under control through comprehensive and effective
financial regulation.
Sources:
People’ Bank of China – “China Monetary Policy Report Quarter Two”, (August 2, 2012) Available at: http://www.pbc.gov.cn/image_public/UserFiles/english/upload/File/China%20Monetary%20Policy%20Report,%20Quarter%20Two(7).pdf [accessed 11/12/2013].
McKinnon, Ronald, Lee, Brian and Yi David Wang (2009): “The Global Credit Crisis
and China’s Exchange Rate”, The Singapore Economic Review, Vol. 55, No. 2 (2010) 253–272. [accessed 12/03/2013].
Zhang, Zhichao, Li, Wei, Shi, Nan, “Handling the Global Financial Crisis: Chinese
Strategy and Policy Response” SSRN working paper. Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1377049 [accessed 11/03/2013].
Zhang, Moran “China: The recovery may come earlier than expected”, –
http://www.ibtimes.com/chinas-economy-rebound-sooner-stronger-expected-nomura-789792 – September 17 2012 [accessed 11/03/2013].
For many years, China has been very much conservative in fiscal expansion. China’s fiscal revenues as a share of GDP increased from 11 per cent in 1997 to 21 per cent 2007. In 2008, the ratio of fiscal deficit to GDP amounted to a mere 0.6%; the ratio of public debt to GDP was only about 20%. Therefore, China has a very strong fiscal position for implementing the stimulus package and even for enlarging its scale if necessary. Similarly, China’s banking sector basically remains sound and healthy. The average ratios of non-performing loans (NPL) for all commercial banks and state-owned banks have been successfully reduced from 25% in 2002 to about 6% in 2008. The leverage ratio of the Chinese banks has been very low. The loan-to-deposit ratio in 2008 was only about 63%, lower than many emerging market economies. The sound banking sector will provide more room for the possible deterioration of a loan quality.
However, there are also some risks and problems. Firstly, much evidence indicates that some of the new bank loans have been infused into the stock markets and property markets. From November 2008 till July 2009, the Shanghai stock composite index (A share) increased by 110 %, reaching 3300 points from 1600 points. Since February 2009, the housing prices in some coastal cities have surged by 40% on average. Obviously, the asset bubble problem has once again become a big concern now. Since July, the authorities have decided to control the increase of bank credits, which eventually caused the new bank lending shrinking to 355.9 billion Yuan in July or a sharp fall by 77% from the latest peak amount in June. It is clear that the monetary policy is facing a dilemma. If the authorities continue to control the bank credits and even switches to moderately tight monetary policy, then many new projects may suffer from shortage of expected new funding injection and eventually become problem projects and the bank loans injected early may become non-performing. If it gives up the efforts to control the crazy surge of bank loans, the asset bubble may become very serious in the near future.
Secondly, the stimulus package might strengthen China’s reliance on the investment-driven growth model if the money cannot be used more correctly. Since the late of 1980s, owing to the rapid the industrialization and urbanization and the deep integration into the world production network after its access into WTO, China’s economic growth has increasingly relied on the investment in industrial sectors. Under such a growth model, China’s industrial sector has been much larger while the service sector is much smaller, compared to the average level in the world (even in developing world). By implementing the RMB 4 trillion fiscal stimulus packages, China should have a good chance to make a better balance between the two sectors, but it is also likely to make the structure more imbalanced in the future. As we mentioned above, the spending on education, medical care, social security and other modern service sectors are quite limited. It would be more helpful if the government could finally increase the weights of the investment in these areas.
Thirdly, keeping Renminbi exchange rate relatively stable and restoring export stimulating measures, such as increasing the tax rebate rates for some exports may slow down the process of reducing the economy’s excessive reliance on external demand. These policy responses are somehow necessary for eliminating the negative external shocks. And keeping exchange rate stable is also helpful for improving the effectiveness of fiscal expansion (McKinnon and others, 2010). But if these export stimulating policies, as a short-term policy response, wrongly remain in the long run, China’s structural adjustment may be delayed. Therefore, when the external shock dissipates, it is necessary for the government to allow the Renminbi to appreciate gradually in accord with the need of structural adjustment.
Finally but not least, it would be a big challenge for the central and local governments to avoid mistakes in selecting investment projects at microeconomic level. Accordingly, a rebound of nonperforming loan rate seems to be unavoidable. It is really important to keep it under control through comprehensive and effective financial regulation.
Sources:
Chiu, Lisa, ‘China’s Response to the Global Financial Crisis’ http://chineseculture.about.com/od/thechinesegovernment/a/Chinaeconomy.htm – [accessed 11/03/2013].
People’s Bank of China – “China Monetary Policy Report Quarter Two”, (August 2, 2012) Available at: http://www.pbc.gov.cn/image_public/UserFiles/english/upload/File/China%20Monetary%20Policy%20Report,%20Quarter%20Two(7).pdf [accessed 11/03/2013].
McKinnon, Ronald, Lee, Brian and Yi David Wang ‘The Global Credit Crisis and China’s Exchange Rate’ (2010) The Singapore Economic Review, Vol. 55, No. 2, 253–272.
Maurice Obstfeld and Kenneth Rogof ‘Global Imbalances and the Financial Crisis: Products of Common Causes’ (2009) Paper prepared for the Federal Reserve Bank of San Francisco Asia Economic Policy Conference, Santa Barbara, CA, October 18-20, 2009. Available at http://www.parisschoolofeconomics.eu/IMG/pdf/BdF-PSE-IMF_paper_OBSTFELD-ROGOFF.pdf.
Zhang, Zhichao, Li, Wei, Shi, Nan, “Handling the Global Financial Crisis: Chinese Strategy and Policy Response” SSRN working paper. Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1377049 [accessed 11/03/2013].
Zhang, Moran, ‘China: The recovery may come earlier than expected’ http://www.ibtimes.com/chinas-economy-rebound-sooner-stronger-expected-nomura-789792 – September 17 2012 [accessed 11/03/2013].
This mass spending and lending helped China weather the global crisis . It now however has a huge amount of unpaid debt. Much of the loans that went into infrastructure ended up being invested into construction more notably into Ghost cities which have contributed to the housing crisis with the affluent members of China pouring money into property seeking out a safe investment as opposed to leaving it in the bank to deflate. The Chinese banks and government has come under scrutiny due to the cover up of bad debts. its believed that the reported figure of bad loans is significantly lower than the actual value.
The train lines built we’re rushed and haven’t benefited the rural areas as they bypass them further increasing the economic freedom and mobility of the poverty stricken rural areas. The rushed construction led to a crash in July killing 40 people. The Government was right to increase spending to prop up the economy in light of the reduced demands for exports. It may now however have to deal with the crude execution of the spending.