Chinese Economy: Current Issues and Future Scenarios

FAN Gang

National Economic Research Institute

China Reform Foundation

November, 2004

Trends or Scenarios:

• Short-run: possible soft-landing: Government took actions much quicker;

• Long-run: Possibility of high growth for another decade—fundamentals are still favorable.

Short-run Growth Cycles

There has been a Over-heating again

GDP Growth, Chi na

6

6. 5

7

7. 5

8

8. 5

9

9. 5

10

10. 5

1997 1998 1999 2000 2001 2002 03. Q1 03. Q2 03. Q3 03. Q4 04. Q1 04. Q2 04. Q3

The main contributor: Investment Boom

0

5

10

15

20

25

30

35

40

1997 1998 1999 2000 2001 2002 03. Q1 03. Q2 03. Q3 03. Q4 04. Q1 04. Q2 04. Q3

GDP Growth rates % Real growth of Gross domesti c i nvestment % Real growth of retai l sal e of consumer goods %

Price Indece

-6

0

6

12

1997 1998 1999 2000 2001 2002 03.Q1 03.Q2 03.Q3 03.Q4 04.Q1 04.Q2 04.Q3

CPI Input PI

Chi na' s Trade bal ance

-30

0

30

60

1997 1998 1999 2000 2001 2002 2003 04. Q1 04. Q2 04. Q3Year

US$ bn

Why should (Chinese) economists worry about?• Potential growth rate: 8-9%;

• Early find-tuning to stop the acceleration!

• The economy is vulnerable to the fluctuations;

A nice Soft-landing is highly likely

• Government was quite quick to respond, so the over-heating was not fully developed;

• Realistic policies, including administrative ones;

• No hard-landing, if policy-making with normal wisdom.

What will be the next?

• With the growth rate back to the zone of 8-9%, China may continue the current boom for next 2-3 years;

• While macroeconomic stability stays, more reforms will take place: banking, capital market, taxation…..

Long-Run Development

China is full of Problems and difficulties: Two Sets

Set I. As a developing country -- Per capita GDP US$1,000 by 2002; 65% of population

are rural. * Industrialization * Modern corporate system * Financial market development * Rule of law * Rural-urban difference and urbanization * Regional disparity and migration * Opening and competition * Unemployment: various categories * Democratization …………

Set II. As the economy in transition

-- Legacy of Soviet-type system, currently 80 millions working as state employees.

 

* The state owned enterprise (SOEs)

* The state banking system

* Social security system

* Planning to Market

* Government reform and political changes

……

Achievements or Reasons for Achievements

• No longer as a State company dominated economy (up to 70% of GDP comes from Non-state sectors, most of small SOEs privatized);

• Opening up (trade and FDI, WTO);

• Decentralization of decision-making and diversification of society.

Major concerns

There are many concerns about if China’s growth would be interrupted by any kind of crises or upside downs.

2 biggest selected:

– Financial crisis: NPL, etc,

– Social crisis: Unemployment and social instability;

Financial Risks

• Financial Reform is seriously lagged behind as a bottleneck;

• Foreign participation may cause financial difficulties for the state banks, but may improve the overall quality of financial assets, and therefore reduce the risk;

• For the state banks, the NPL risk is still manageable.

Indicators of Financial Risks of Chinese Economy (%) 2000 2001 2003*

NPL over GDP – official statement 25.0 27.3 23.6 Liability of AMCs over GDP 16.0 13.4 10.0

Government domestic debt over GDP 14.5 16.3 17.2 Total foreign debt over GDP ratio 15 14.8 13.9

Short-term commercial debt over GDP ratio 4.3 4.5 4.9

“Overall National Contingent Liability” 70.5 71.8 64.7

“Short-term NCL” 59.8 61.5 55.7 GDP Growth rate 8 7.4 9.1

Budget deficit as % of GDP 2.8 3.0 2.2

Interest rate on government bonds (1 year) 2.4 1.75 1.75

Growth rate of budget revenue (3 year average) 19 20 20

Current account balance US$ billion 20.5 17.4 35.0

Capital account balance US$ billion 19.2 34.7 79.0

Foreign exchange reserve, US$ billion 16.5.1 210.0 403.3

Inflation rate 0 0 1.7 * Most of figures for the end of 2003 are estimated based on the data of previous quarters.

Unemployment

and

Social Stability

Basic facts:

• 25 millions of state workers were laid off in past 5-6 years; 6 millions still unemployed; at least 20 mil. More to come.

• 45% of labor force, or 350—400 millions, are still dependent on farming, mostly under-employed;

• 15 millions new non-farming jobs created by 7-8% growth per year;

Why is still there the social stability

• Special programs for the laid-off state workers;

• New job creation by the growth;

• Improvement of labor mobility;

• Rural land system serving as China’s special social security for the rural unemployment;

The realistic policies:

• Prepared to go through a painful historical process of modernization;

• Do not raise the expectations for the government subsidies;

• Do more for education within the budgetary affordability;

• Increase gradually the medical protection of the rural poor.

Foreign Exchange Issues

• Most South-East Asian currencies have been floating after 1997;

• But China was forced to return to fixed regime since then.

Market speculation still strong

Foreign Exchange Reserve (US$bn)

0

100

200

300

400

500

600

1997

1998

1999

2000

2001

2002

03.Q

1

03.Q

2

03.Q

3

03.Q

4

04.Q

1

04.Q

2

04.Q

30102030405060708090100

Forei gn Reserve (US$bn) Growth of FX reserve quarter l y

Revaluation seems less urgent in past months:

-- Overall trade balance;

-- Inflation is increasing;

-- Uncertainty about the oil price and its

impacts;

-- US$ was not fast weakening until recently

The real Issues:

• How to de-peg from US$, and change to a basket-pegging system with higher flexibility? – That is China’s self-interest, not others’.

• How to minimize the speculation;

• How to catch up the good opportunity in the market to do so?