# Struggling forward: China comes up

Date December 20, 2001 Fan GANG(National Economic Research Institute, China Reform Foundation)

## Summary

It is my pleasure to share with you some of the policy issues that are under debate on the Chinese economy, including macroeconomic issues, the exchange rate, financial reform and risk, and the development tragedy issue. Now what is interesting about the Chinese economy is the macroeconomic situation and policies. This year the GDP grew 7.3 or 7.4%, which is a slowdown from previous years, but still quite satisfactory. Growth has mainly come from domestic and overall investment, which grew dramatically. Investment grew by 15%, which is higher than last year's 5%. Included in this number, foreign direct investment increased by 21% by the end of September, and annually by around 20%. At the same time, domestic investment also grew, particularly non-government investment. Government investment is not making a direct contribution to the growth. While the government is helping to improve the investment situation, there is no increase in the governmental investment.

One of the reasons for the drop in GDP increases may come from external factors. Export growth will be 5 or 6%, and the trade surplus may not decrease very much. By the end of November, the trade surplus was US$20 billion, and this year would be US$24 billion, like last year. Net imports do not change very much, much better than expected earlier in the year. Chinese exports did not decrease with the international IT bubble because China did not have many IT industries like US, Singapore, Japan, or Korea. But the Guangdong province was affected, as it has more IT companies. Zhejiang province had a 20% increase in exports, which were mainly Chinese traditional manufacturing.

The second reason may come from the adjustment of demand. For example, the global slow down and Chinese production occupied a large amount of the foreign market. And consumption growth slows down with income growth. In this year, consumption grew by 10%, real estate by 30%. Investment in real estate and consumption relating to housing are major parts.

We predict no big slowdown for China economic growth in the near future. Next year will also see 7% growth.

But now the problem is deflation. It is really a big problem for short-run investment growth. Deflation is said to have started early this year. The retail price index has turned negative. The reason for deflation is that we are suffering from a credit crunch. In September, there was only a 1.6 billion Chinese yuan increase in the major bank credit, which is quite low.

Another issue people talk about is the exchange rate. The RMB actually appreciated in real terms, not only because the Asian financial crisis, but also since last year nearly all Asian currencies and the euro depreciated against the US dollar. The RMB is pegged to the US dollar. This significantly affects Chinese exports and imports. The trade surplus is predicted to narrow. Trade in the Asia-pacific region accounts for 60% of total Chinese trade, so the appreciation of the RMB has a big impact. At the same time, China does not face depreciation pressures. The capital account is positive; foreign exchange reserves are high (by the end of this year, it could reach $210 billion, an increase of$40 billion in this single year). It is clear we do not have an incentive to appreciate. Talking about what the RMB would do given a depreciation of the yen, we suggest that it will follow, in tandem. We do not think it is possible for China to do the same thing as in 1997. Anyway, RMB is quite stable, as long as the yen does not depreciate significantly.

The third issue is financial reform and financial risk of the economy. A major concern is the non-performing loans (NPL). The central bank announced that the total was over 25% of GDP ratio of 25%, which is large. And the liability of AMCs is over 16% of GDP. A total of 40% is taken into account. But domestic debt is very low, only 14.5% of GDP. Although foreign debt is 15% GDP, only 1% is short-term debt. China treats it quite well. The overall national contingent liability is 70.5%. Financial risk is not as high as it is in Western Europe. Overall financial risk is still manageable. We want to push financial reform, but banks that use their high non-performance loans to influence the government, said if we do too much, we will suffer from a financial crisis. According to the indicators above, we can conclude that no such danger would happen.

WTO is the major push for the financial reform. Manufacturing industries have been opened to foreign investors and domestic private companies. Actual tariffs were much lower than nominal rates. While service sectors, such as banking, insurance, telecommunication, have been promoted, they were the main subjects of WTO negotiations. Companies in new, rising industries, such as insurance and telecommunication, are mainly facing the issue of market sharing or profit sharing. While companies in old or established industries, such as banking, are facing issue of downsizing or lay-offs, as new competitors enter the market.

Generally speaking, the private sector is more competitive and more flexible to adjust to this new environment. The state sector will have more difficulties when protections are removed. People are more talking about China become the world factory. However, China still cannot get rid of the labor-intensive manufacturing. In the early years, state-owned enterprises used public funds to import high-tech equipment and technology to increase competitiveness. Yet, the costs of such imported equipment were too high, so they were not competitive. Now the government has become more realistic. They claim to develop their own technology, and there is a shift from labor-intensive manufacturing to the capital technology intensive industries, although it will really take a long time.

The short-run for the WTO accession of China may lead to export growth and rising foreign investment, due to the improvement of investor confidence in China. During the short-medium term, painful structural adjustments and institutional reforms will take place for five to ten years, longer than the transition period for WTO. Finally new initiatives for reform ensure China continues on the path of opening to modernization and globalization. How China will perform will depend on how the reforms proceed. All on-going reforms, including restructuring the state enterprises, banking sector reform, must continue. The government also begins new reform programs this year, such as social security reform (unemployment insurance, pension and medical care), capital market development, and government reform (reducing government approvals and controls, improving efficiency and transparency, and breaking down SOE monopolies).

We believe that China will maintain a 7 to 8% growth rate for the next 20 years, and will become the new center of manufacturing industries for the world.

*This summary was compiled by RIETI Editorial staff.