Download - China Macroeconomics Analysis (1996-2009) by Denise Odaro, Geoffrey Kau, Ivy Zhao, Shirley Liu, Keanu Che

8/9/2019 China Macroeconomics Analysis (1996-2009) by Denise Odaro, Geoffrey Kau, Ivy Zhao, Shirley Liu, Keanu Che

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ECON-520

ChinaMacroeconomics

Analysis

1996-Current


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Geoffrey Kau

Ivy Zhao

Shirley Liu

Denise Odaro

Keanu Che

Preface:

How did China get on track to fast becoming a powerhouse the world? From the 1890s

its role in the global economics was reduced significantly. In 1949, the Chinese

Communist party established China's current government which implemented a

transition to a planned economy starting in the 1950s. It was not until the late 1970s

when the Chinese government began a transition from a closed economy to a

somewhat more market oriented approach and in the following 30 years, China has

come a long way from 1978 when Deng Xiaoping laid the groundwork for a reform. At

the time, more than two-thirds of the Chinese population lived in the rural countryside

producing surplus labor through which China could achieve rapid, growth for almost

two decades without facing wage pressures. In addition, China had a trained and

regimented labor force. The percentage of technical experts in the industrial labor

force was higher than in other emerging South-East Asian economies. These unique

elements contributed to a positive foundation for what was to follow.

The economic reform kicked off in 1979 and the established goal was to generate

sufficient surplus value to finance the modernization of the mainland Chinese

economy. It began with a combination of changes in regulation by plans andintroduction of regulation by the market in key areas such as: State Owned

Enterprises (SOEs), finance, taxation, pricing and foreign trade. The initial reforms

included the inauguration of the Household Responsibility System by which farmers

were able to retain surplus over individual plots of land rather than farming for the

collective. This was followed by the establishment of TVEs - industries owned by

townships and villages. Imperatively, an open door policy also begun, by which


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international trade and foreign direct investment was allowed.

The second step in the reform program transpired in the 1980s and the objective was

to create market institutions and convert the economy from an administratively driven

to a price driven market economy. This was accomplished by the dual track pricing

system in which some goods and services were assigned state controlled prices andother goods were at market determined prices. Eventually, goods at market prices

were increased, until they included almost all products by the late 1990s. Concurrently

the government ran the crucial SOE restructuring in four stages:

1979-1983: Initiatives were launched including profit retention,

performance related bonus and production outside the mandatory plan;

1984-1986: Profit tax replaced profit remittance and SOEs were

permitted to sell their surplus on the free market;

1987-1992: A contract responsibility system was introduced

making managers more responsible for the economic state of their

assigned divisions;

1993: SOEs were given further autonomy and made more

economically oriented with independent budgets and self-responsibility

policies

These initiatives immediately increased the standard of living for most of the Chinese

population and the poverty rate has decreased significantly, down from 53% in 1981to 8% in 2001 when China was admitted into the World Trade Organization. Chinas

output rate had consistently grown throughout the preceding 20 years. China's

economic revolution has created a large middle class. Although wages have increased,

they still remained below those in the rest of the industrialized world thus keeping

Chinese goods competitively priced.

Now we will introduce China macroeconomic development in recent years from 1996-

present.

Scenario 1: 1996-2001

The growth of the world economy from 1996 to 2001 featured somehow slowdowns,

with various developed countries plunging into economic recessions or economic

downturns synchronously. Against this context, China was able to maintain high

growth. A simple direct comparison of economic growth of all countries shows that

China outshone all the others.


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Chinas economic growth from 1996 to 2001 exhibits the following features:

1. In general, Chinas economic growth has stopped sliding and has tended to

stabilize in the 1996-2001 period, maintaining sustainable stability. For six years in

a row, Chinas economic growth operated steadily between 7-8 percent (see Chart

1). Following its 1992 peak growth of 14.2 percent, it slid steadily for sevensuccessive years from 1993 to 1999. The expansionary fiscal policy helped arrest

the downslide trend in 2000, resulting in a slight recovery. Between 1998 and 2001

Chinas economic growth rate stopped sliding and steadied at the level of 7-8

percent.

Chart 1:GDP Growth Rate

9.6 8.8

7.87.1

87.3

0

2

4

6

8

10

12

1996 1997 1998 1999 2000 2001

Source:IMF

2. The demand structure for economic growth in these six years shows that the

contribution by external demand exhibited a declining trend while that by domestic

demand began to rise. In 2001, in particular, the contribution by external demand

was negative. Domestic demand alone causes the economic growth. Of the

domestic demand, the ratio of consumption to investment improved in years

between 1995 and 2001, but has not yet achieved the optimal state. Domestic

demand contributed 8 percentage points while net exports contributed 0.7

percentage points (see Table 1).


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Table 1: Demand Structure of China's Economic G

Year GDP growth(%)Contribution by fina

consumption(%)

Con

for

1996 9.6 5.1

The situation from 1996 to 2001 shows that the contribution to economic growth by

net exports in 1997 reached a high of 3.6 percentage points while such contributions

have been declining since the beginning of 1998, down to 0.015 percentage points

by 2000, nearly zero, and further down to 0.7 percentage points by 2001. This

indicates that the Asian financial crisis since 1997 and especially the economic

downturn of all major developed economies including the United States in 2001 have

had an adverse effect on Chinas economic growth. Since 1998, the contributions by

domestic demand to economic growth has been rising, from 5.2 percentage points in

1997 to 8 percentage points in 2000 and 2001. This indicates the result of the policy

of expanding domestic demand. With regard to domestic demand, the final

consumption contribution rose from about 3 percentage points in 1997 and 1998 to

about 4-5 percentage points in the past three years while the contribution by capital

formation ended the declining situation (dropping from 6.9 percentage points in

1995 to 0.9 percentage points in 1999) and rose to 2.9 percentage points in 2000

and to 3.6 percentage points in 2001.

3. With regard to macroeconomic control by the government, China has been

implementing an expansionary fiscal policy and prudent monetary policy in 1998-

2001. Since 1998 the Chinese government has adopted an expansionary fiscal

policy in order to cope with international financial turmoil, world economic

downturns and inadequate domestic demand. Between 1998 and 2001, the central

government issued more than 500 billion Yuan of special construction bonds. By

2000, the debt receipts of the state had reached 418.01 billion Yuan, 4.7 percent of

the GDP. The central governments fiscal deficits (not including debt receipts and

expenditure) made up 2.8 percent of the GDP in 2000 and 2.58 percent of the GDP

in 2001 (the warning line commonly accepted internationally is 3 percent). While

pursuing this expansionary fiscal policy, the Chinese government adopted a sure

and steady monetary policy in order to guard against financial risks. The growth of

M0 has dropped markedly in the past two years (See Table 2). The growth of


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narrow money, M1 has assumed a declining trend in 2000 and 2001. The broad

money, M2 has been lingering at below 15 percent over the years from 1998 to

2001.

Table 2: Growth of Money Supply (%)

Year M0 M1 M2

1996 11.6 18.9 25.3

1997 15.6 22.1 19.6

1998 10.1 11.9 14.8

1999 20.1 17.7 14.7

2000 8.9 15.9 12.3

2001 7.1 12.7 14.4

Source: China statistical yearbook

The most prominent feature of Chinas economic growth over 1996 and 2001 as

shown above is that the growth rate has been maintained at a 7-8 percent level for

four successive years. This shows, on the one hand, that the Chinese government has

been successful in its expansionary fiscal policy and prudent monetary policy while

resisting the impact of international economic slowdowns and financial turmoil, and

that it has overcome the inadequacy in domestic demand. These achievements were

hard-won. On the other hand, we see that in increase of GDP is largely driven by

domestic investment, especially the government spending. The real problem is still

the inefficient domestic demand. In order to solve this issue, China government should

take effective policies to encourage non-government investment in the long run.

Scenario 2: 2001-2005

Highlights

In the years of 2001-2005, China experienced high growth with low inflation

development period. The However, the export-oriented economy resulted in the huge

increase on the current account surplus. The tremendous foreign exchange surplus

brought a big pressure for RMB appreciation, which was the driving force of foreign

exchange rate reform.

GDP Growth

China was undergoing steady and fast economy growth in the period of 2001-2005.

The average GDP growth rate is 9.54%, and the average inflation rate had been

controlled below 1.2%. Although the western countries suffered from the apparent

slowdown in 2001 because of Dot.com bubble and the 911 attacks, China experienced


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the high growth at that time. Although in 2003, SARS infected the national economy

negatively, China did not stop growing and recovered from the short-term negative

impact soon. Overall, this was a golden developing period, which had high growth rate

with low inflation rate.

Driving

Force of

Growth

The major

engine of this strong growth was manufacturing trade, where China was verycompetitive, and its industrial production. Chinas strides in industrial production have

been phenomenal. Most of China export goods were final consumer goods and raw

materials. The low labor cost provided China strong competitive advantages in global

market after accession of WTO. On the other hand, some natural resource based

exports was very vibrant as well. Chinas goods-dominated strategy attracted many

foreign investors came into China to set up factories, some of which were OEM

manufactories and exported the finished goods. This action stimulated both foreign

investment and exports. So the foreign direct investment had significant increase in

this period.

Table 4 (USD million)

Year FDITotal

Exports% of GDP

Table 3 (RMB 100Million)

YearNominal

GDPReal GDP

GDPGrowth

Rate

Inflation

rate

2001109655.17

06107449.67

748.30% 0.70%

2002120332.68

93117208.33

019.10% -0.80%

2003135822.75

61128958.90

9210% 1.20%

2004159878.33

79141964.46

6610.10% 3.90%

2005 183217.4156775.27

3910.20% 1.80%

*Source: China Statistical Yearbook


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2001 46880.00 267611.18 20.09%

2002 52740.00 327434.99 22.39%

2003 53500.00 438259.66 26.72%

2004 60630.00 593035.02 30.71%

2005 60330.00 777271.71 34.22%

*Source: China Statistical Yearbook

Foreign trade has actually become the real "engine power" to China's economic

growth. In 2004, China became the world's third largest country in foreign trade, with

exports accounting for over 30 percent of the country's GDP. The export oriented

strategy caused the twin surplus: current account surplus and capital account surplus.

On the other hand, the loose monetary policy used by major western countries, such

as US, which continuously implemented the low interest rate policy to stimulate the

liquidity, particularly after Iraq war, caused more international capital to flow into

china. Since China used fixed exchange rate policy at that time, the international

capital inflow impelled Central bank of China to supply huge amount of currency to

meet the increasing demand of RMB.

Table 5: Foreign Exchange Reserve (USD Billion)

Year 2001 2002 2003 2004 2005

Foreign ExchangeReserve

212.165

286.407

403.251

609.932

818.872

*Source: State administration of Foreign Exchange

The huge amount of foreign exchange reserve made the RMB face the huge pressure

of appreciation.

Foreign Exchange System Reform:

On July 21 2005, the People's Bank of China, China's central bank, announced that the

exchange rate of RMB VS. USD was traded from fixed 8.28 to 8.11. The RMB to US

dollar pegging system was switched to a basket of foreign currencies. The foreign

exchange system reform brought China economy into new stage. Meanwhile, the

reform directly results in the RMB appreciation gradually in the following years. The

traditional export-oriented economic structure faces the new challenges.


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Scenario 3: 2006 Current

GDP and Inflation during the Boom Years: 2006-2008

From 2006 to 2008, China continues to see tremendous GDP growth. Real GDP growthin 2006, 2007 and 2008 are 11.6%, 11.9% and 9%, respectively. GDP growth is

mainly fuelled by increases in net export and investments.

Source: EIU

During that time period, global demand rose significantly with the booming markets

and easy credit. Foreign investors obsession with emerging markets, especially

China, resulted in a significant inflow of money to China. Foreign consumers also had

an insatiable hunger for Chinese goods. Net export continued to add weight in the

GDP composition from 2006 to 2008. Net export as a percentage of GDP went from

8.8% in 2006 to 11.9% in 2008.


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Source: EIU

GDP per capita started soaring in 2006 and so did property prices and the stock

market. GDP per capita went from $4,796 (USD at PPP) to $6,076 in 2008. The

Shanghai A Share Price Index went from 1,319 at January of 2006 to an all time high of

over 6,000 in October of 2007.Chinas foreign reserves during thisperiod also

ballooned from $1,073 billion to $1,956 in two years from end of 2006 to end of 2008.

During this period, China started to see rampant inflation caused by the overheated

economy and its old peg to the dollar. The inflation rates were 2.4%, 4.4%, and 5.9%

(average % YoY) for 2006, 2007, and 2008, respectively.

China took measures to counter this phenomenon by enacting laws aimed at cooling

the stock and real estate markets. It also tightened bank lending and let the RMB

appreciate gradually. The Chinese government imposed new taxes on stock

transactions and added limits to mortgage lending to curb growth in those markets.

Interest rate went from 5.6% (average) in 6.1%, 7.5%, and 7.9%, in 2006, 2007, and

2008, respectively. The Chinese Yuan also appreciated against the dollar, the currency

of its largest trading partner, from 8.1RMB:1USD at January of 2006 to 6.8RMB:1USD

at end of 2008..

The Downturn and a Look into the Future

In 2008 China saw a sharp downturn of economic activities, caused by the global

slowdown and liquidity crunch. As demand slows and investors stop throwing money

in, Chinas GDP growth rate went from 10.1% YoY in 2Q 2008 to 6.8% in 4Q 2008. The

majority of the slowdown is caused by the sharp decline in exports, since the

consumption power of its foreign customers have dropped significantly.


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Source: EIU

As the main growth driver for Chinas GDP, a decline in export would mean serious

trouble in China. In the forecast by the Economist Intelligence Unit, Chinas GDP

growth is predicted to be only 6% with a negative growth rate of 10% in net export.

At the same time, Chinas inflationary worries have turned into a fight against

deflation. CPI is forecasted to be at -0.2% YoY change in 2009.

Chinas FDI inflow, which saw a CAGR of approximately 20% from 2006 to 2008, is

expected to drop for the first time since 1998. Even though FDI is not as significant to

China as a source of funds for investment today, it is still important for Chinas growth.

From Chinas policies on FDI, we will be able to see what Chinas intentions are for

future development.

In 2008, China changed its policy on FDI in a change of strategy for future

development. The new policies encourage investing in modern and sustainable

technologies. It wants to curb investing in operations that feature out-of-date

technologies and productions that are resource and energy intensive. It is also

directing investment to regions in the less developed western parts of China, as the

disparity in advancement and income between coastal and inner regions is becoming

quite significant. A less expected set of policies are discouraging export-only

enterprises because China wants to control its trade imbalance and excessive

accumulation of foreign reserves.


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However, China has more urgent problems at hand: how to prop up GDP growth to

ensure social stability. After all, rising unemployment and sliding consumer confidence

will surely work against the governments goal to ensure harmonious growth. To

make up for the loss in net exports, the Chinese government will likely be focusing on

two things: increasing public spending and boosting bank lending. The central

government has already announced plans for a 4trn RMB fiscal stimulus to boost

public spending, focusing on infrastructure development. China has slowly lowered

interest rates since 2Q 2008, the prime lending rate went from 7.5% in 2Q 2008 to

5.3% in 4Q 2008. It will likely be lowered further in 2009. The main issue with

increasing lending will be to ensure that the funds are allocated efficiently to achieve

maximum effect in supporting growth.

Even though some are hoping private consumption will increase to support growth, it

is unlikely that it will be a significant contributor. In an environment with rising

unemployment, the consumers are likely to increase savings than consuming more,

especially in a country with a weak social welfare system. Cutting taxes and handing

out stipends and cash handouts will likely only achieve marginal effect.

Looking forward, China will need to prove itself in the face of crisis. In fact, some are

counting on China to lead the world out of the recession. Even though it is unlikely

that China alone will be able to achieve this, its actions will impact the global economy

significantly.

Summary of China Macro Economy Development in Recent Years

To sum up, we looked back the past twenty years, it was a rollercoaster experience for

China macro economy. Given all the ups and downs, one thing has clearer and widely

recognized, which is China has played and will continue to play a critical role in global

economy. Especially when the most developed economies have been suffering from

the current financial turmoil and probably or already stepped into recession. China is

one of the few countries who have been the exhibited robust economy growth.

Looking ahead, China has claimed and gained bigger say in global event as China

stands up to be a major power and significant portion of word economy. While the G20

summit is about to convene in London, BRIC and some other emerging economies

insist developing countries should have a bigger say in multilateral financial discussion

and relevant policy-making process. As the global financial crisis unveils defects of the

existing international financial system, BRIC, which include Brazil, Russia, India and


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China, more than ever pointed out a few developed economies simply exercise

monopoly in global financial rule making, while developing countries have long been

marginalized unfairly.

Earlier March 2009, Chinese Financial Minister Xie Xuren called for substantial and

overall reforms of the international financial system, and endeavour to a new one

featuring fairness, justice, rich inclusion and order.

The legend continues. China's announced economic stimulus package, amounting to 4

trillion yuan, will work to achieve the economic growth at 8 percent and lay a good

foundation for next year's growth by starting the economy's clean-up process of the

inventory this year.

Chinese government has unveiled a 4 trillion yuan stimulus plan to prop up the

economic growth in a global economic downturn during which China has already

suffered a slowdown of GDP growth from above 11 percent in 2007 to 9 percent last

year.

While the 4 trillion stimulus package is working relentlessly to prop up domestic

economy, China also speaks out to the world in the very time when global financial

crisis is devouring and damaging the worlds wealth.

Chinese central bank governor Zhou Xiaochuan advocated that it was uncertain

whether China's economic slowdown had ended and he urged more financial reforms

in the face of the worldwide slump.

Premier Wen Jiabao said, during the National Peoples Congress and National

Committee of CPPCC annual sessions 2009, it is "difficult" to achieve the country's 8

percent GDP growth goal for this year, but said it is still "achievable". The remarks

injected confidence in the national economy and indicated China has taking measures

and is capable to generate 8% GDP growth given the major world economies and

many Chinas trading partners have slid into recession or on the edge into it. The

worldwide financial crisis again grants China the chance to lead the economy growth

and showcased the robustness of China Macro economy. We hold very positive stanceon Chinas macro economy in the years to come.