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Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia : East Asia

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People's Republic of China

In spite of the global economic slowdown, the People’s Republic of China maintained its robust economic expansion in 2001, though some signs of slowing appeared in the second half of the year, due partly to a sharp deceleration in growth of external trade. Driven by domestic demand and supported by World Trade Organization accession, the macroeconomic outlook for 2002–2003 is bright.

Macroeconomic Assessment

The People’s Republic of China (PRC) remained one of the best-performing economies in the Asia and Pacific region in 2001, with GDP expanding at a rate of 7.3%. However, there were clear signs of deceleration in the second half of the year, with GDP growth slowing from a quarterly rate of 8.1% to 6.6% between the first and fourth quarters.

The industry sector posted a gain of 8.7%, led by the robust performance of foreign-invested enterprises. Their value added rose by 11.9% in the year, compared with 8.1% for state-owned enterprises (SOEs). The services sector grew by 7.4%, supported mainly by high growth in transport and telecommunications. Suffering from a severe drought and a decrease in the planted area, the agriculture sector grew by 2.8% in 2001. Grain output declined by about 2.1%, following a 9.1% drop in 2000.

Investment rose strongly by 12.1%, pushed by fiscal stimulus measures and accelerated foreign direct investment (FDI) inflows. However, momentum declined after August 2001, in which month investment had surged to 21% year on year, slowing to only 9.4% in November. One characteristic of investment during the year was a sharp rise in flows to the western region where economic development has lagged far behind that in the eastern and central regions: investment growth there was 5.1 percentage points higher than in the rest of the country. In contrast to high growth in public sector investment, that in the private sector stayed weak, partly because of a shortage of loanable funds available to the sector from the banking system and partly because of a generally cautious attitude toward lending to the private sector, especially to small and medium enterprises (SMEs).

Due to increasing incomes, retail sales strengthened by 10.1% in 2001, a slightly higher rate than in 2000 (Figure 2.1). Purchasing power stayed largely in the hands of urban residents, as the Government increased salaries for civil servants and pensions for government retirees twice during 2001. A large increase in automobile credit and housing mortgage lending also stimulated domestic consumption demand. Although rural income and consumption rose more rapidly in 2001 than in 2000, the rates of growth still trailed those in urban areas.

Inflation rose slightly in 2001, partly because of an upward adjustment in government-controlled prices of utilities and services. The consumer price index edged up by 0.7%, compared with 0.4% in 2000. However, some deflationary pressure built up as economic growth slowed in the latter part of the year, and prices fell slightly.

The official estimate of urban unemployment in 2001 was 3.6%, putting it slightly higher than in 2000. However, this does not cover workers who were laid off as part of SOE restructuring and who have not found new jobs. The reemployment rate of these workers, which has been declining in the past 3 years, is an important determinant of real urban unemployment.

The PRC has significantly reduced rural poverty over the past few years. Sustained, rapid economic growth and targeted poverty interventions brought the number of absolute rural poor in terms of the official poverty line down from 80 million in 1994 to below 30 million, or about 3% of the rural population, in 2001. However, the official poverty line was set in the mid-1980s and is substantially lower than the international standard of a dollar a day. About 213 million people, or 23% of the rural population, still live below that level.

During 2001, fiscal revenues increased by 22.2%, 5.2 percentage points more than in 2000. Fiscal expenditures grew by 18.6%, somewhat less steeply than in 2000. As a result, the fiscal deficit slightly declined to around 2.6% of GDP. However, these official figures give only a partial picture. If the Government’s social security obligations and the costs associated with the nonperforming loans (NPLs) of the state-owned commercial banks (SOCBs) were included, the fiscal deficit would be significantly higher.

Monetary policy remained accommodative to stimulate domestic demand. Broad money (M2) increased by 14.4% in 2001, 2.1 percentage points higher than in 2000. However, M1 growth dropped in the second half of the year, reflecting slower economic activity. Interest rates remained unchanged in 2001, despite declining rates in many other economies in the region and in industrial countries. The asset market fluctuated sharply. Reflecting stronger domestic demand and a better economic outlook, the Shanghai and Shenzhen stock exchange indexes rose by 7% in the first half of the year. In February 2001, the B-share market, which used to be restricted to foreign investors, was opened to domestic investors with foreign currency. As a result, the B-share indexes on these two exchanges soared by about 200% in the first half of 2001, closing the price gap with the A-share market, which is open only to domestic investors. However, both markets experienced a sharp downturn in the second half of the year, triggered by plans to reduce state-owned shareholdings through increasing the volume of share offerings, restricting banks from injecting funds into the stock market, and punishing a number of listed companies for misconduct. Between June and December 2001, the A- and B-share indexes dropped by about 26% and 20%, respectively.

With the global economic slowdown, export growth decelerated sharply to only 6.8% from 27.9% in 2000. This was the result of lower import demand from the major trading partners—United States (US); European Union (EU); Japan; and Hong Kong, China. From 2000 to 2001, the growth rates of exports to these economies dropped from 24.2%, 26.4%, 28.6%, and 20.7% to 4.2%, 7.1%, 7.9%, and 4.6%, respectively. Import growth also slowed sharply, to 8.2% from 35.4% in 2000, largely reflecting a decline in demand for intermediate inputs by exporters. The current account surplus in 2001 dipped to $19.6 billion.

Robust economic growth and accession to the World Trade Organization (WTO) have made the PRC more attractive to foreign investors, and FDI regained its growth momentum in early 2001. Actual FDI inflows rose by 14.9% after 0.9% growth in 2000. Foreign exchange reserves stood at $212 billion at end-2001, or $43 billion higher than 12 months previously, and equivalent to about 11 months of imports of goods. The debt service ratio was 10%.

Policy Developments

To contain the effects of the Asian financial crisis, three fiscal stimulus packages were implemented in 1998, 1999, and 2000 (Y100 billion or 1.3% of GDP, Y110 billion or 1.3% of GDP, and Y150 billion or 1.7% of GDP, respectively). Such investment contributed to the construction of key infrastructure projects, including a rural power network, flood protection structures along major rivers and lakes, environment protection projects, and infrastructure in the western region. Expansionary fiscal policy continued in 2001: Y150 billion in government bonds were issued and a large proportion of the proceeds were targeted to support western region development.

While expansionary fiscal policy has contributed significantly to robust economic growth in recent years, the effectiveness of this kind of fiscal stimulus is probably declining. Furthermore, since a large volume of counterpart funds from commercial and policy banks were needed to match state investment, there has been some crowding out of other private sector investments. However, at the end of 2001, the Government announced that the expansionary fiscal policy would be continued into 2002 as growth in the world economy was expected to be slow.

On the monetary front, the Government focused attention on the performance of the finance sector. During the financial crisis, it intensified financial risk control, helping reduce the NPL ratio of all the commercial banks by 3.8% in 2001. To improve the quality of lending, the career path of bank staff was often tied closely to the quality of loans processed. As a result, commercial banks, particularly the four SOCBs (which still account for 71.8% of outstanding loans), tended to be very careful in making loans, particularly to SMEs in the private sector. It is the private sector though, consisting mainly of SMEs, that is very dynamic and has been growing quickly in recent years. The SMEs also provide the bulk of new employment opportunities. However, their development is seriously hindered by this lack of adequate financing. To encourage the commercial banks to lend to SMEs, more than 200 SME guarantee funds were established by local governments to enhance the credit of SMEs. The central bank also encouraged the commercial banks to increase their lending to SMEs.

More widely, there is a need both to improve the policy environment for supporting the private sector in general and SMEs in particular, and to strengthen the regulatory system (Box 2.1).

To minimize the adverse impact of the slowdown in the global economy, the Government adopted several measures in 2001 to encourage exports, such as speeding up export-tax refunds and customs procedures, and granting permission to private companies to engage in external trade.

In May 2001, the PRC adopted its new 10-year poverty strategy (2000–2010). In it, the Government designated 592 key counties for poverty reduction development work. The selection was based on income, social, geographic, and physical conditions. Priority was given to remote and mountainous areas and minority areas. Poor villages in non-key counties are also eligible for national poverty funding. The Government has placed a strategic priority on promoting development in the western region since 1999.

The PRC became a member of WTO at the end of 2001, and membership involves significant opportunities as well as challenges for the economy. Over the long term, PRC’s accession and its commitments to cut tariffs, liberalize trade and investment, and open up domestic sectors to foreign participation should lead to significant efficiency gains. Hundreds of laws and regulations have to be revised to make them consistent with WTO rules. All these changes will set a foundation for the country to be fully integrated into the world economy. By forcing the economy to reallocate resources in line with its comparative advantage (from capital- to labor-intensive sectors), membership should also generate more employment for a given rate of growth of the economy. It should further improve the country’s export prospects. Many studies estimate that the economy’s long-term gain from WTO membership will be equivalent to about 1–2% of GDP per year.

However, these positive effects will take time to make themselves felt. In the meantime, the Government’s WTO commitments could pose adjustment challenges, especially in protected sectors such as agriculture, automobiles, banking, insurance, and telecommunications. To face these challenges, the Government needs to speed up economic reforms and create a more pro- business environment, including increasing the transparency of regulations, streamlining administrative procedures, and improving legal and accounting practices.

Outlook for 2002–2003

Driven largely by domestic factors and supported by WTO accession, the PRC economy should continue to grow robustly over the next 2 years. Economic growth is forecast at 7% in 2002 and 7.4% in 2003, led by strong domestic consumption and investment. The industry and services sectors should grow by 7–9%, and the agriculture sector by 2–3%.

Domestic consumption and investment will remain strong in 2002–2003 with a growth rate of about 9–10%. Increased domestic consumption and continued solid economic growth will exert ome upward pressure on prices. However, inflation should be moderate at 1–1.5% due to significant excess capacity in many industry subsectors, large unutilized supply potential of the agriculture sector, and cheap imports after WTO-related tariff liberalization.

The fiscal deficit will remain at around 2.8–3% of GDP in 2002–2003. Considerable public resources will be needed to reduce the NPLs of the SOCBs and to implement social security reforms. Substantial funding will also be needed to develop the western region, address poverty, and tackle environment and human resources development problems. Monetary policy is likely to remain accommodative. Money supply (M2) should continue growing by 13–14% in 2002–2003. In an attempt to stimulate the economy, the central bank reduced the interest rate for savings by 25 basis points and for lending by 50 basis points in early 2002.

Assuming that the global economy begins to recover in 2002 and gathers further momentum in 2003, exports are forecast to grow at the rate of 6% and 10%, respectively. With WTO accession, imports will continue to grow faster than exports, and the trade and current account surpluses will gradually decline. However, the decline in the current account surplus will be partly offset by foreign investment inflows as the Government further opens up the economy to fulfill WTO commitments. It is expected that the economy will post a current account surplus of $12.6 billion, or 1% of GDP, in 2002, which will likely fall to about $5 billion, or 0.4% of GDP, in 2003. The official foreign exchange reserves will be close to $230 billion by 2003, while the debt service ratio should fall to below 10%.

The external risks facing the PRC relate mainly to the prospects for global economic recovery, the speed and depth of which remain uncertain. If the improvement in external conditions is much less pronounced than expected, the Government may further strengthen its expansionary fiscal and monetary policies.

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