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p. 18 of 54 BACK | NEXT I. Developing Asia and the World - Economic Developments and Prospects II. Economic Trends and Prospects in Developing Asia Newly Industrialized Economies Central Asian Republics, Azerbaijan, and Mongolia People’s Republic of China Southeast Asia South Asia The Pacific III. Asia's Globalization Challenge

Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia

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People’s Republic of China

Three straight years of expansionary fiscal and monetary policy have helped the economy contain the adverse effects of the Asian financial crisis, maintain a stable exchange rate, and achieve robust growth. The main challenges now are to maintain a high growth rate of aggregate demand in a less expansionary fiscal and monetary environment, and to establish a sustainable social security system.

Recent Trends and Prospects

GDP growth accelerated to 8.0 percent in 2000 from 7.1 percent in 1999, due to an improvement in industrial growth to 9.6 percent from 8.1 percent. The profitability of both private and state-owned enterprises (SOEs) improved as a result of increased consumption demand and reform measures such as debt-equity swaps. The services sector likewise improved, posting 7.8 percent growth in 2000, compared with 7.5 percent expansion in 1999. The agriculture sector, on the other hand, suffered from a severe drought and a decline in retail food prices. Grain output fell by about 9 percent in 2000.

Growth in 2000 was driven mainly by domestic consumption and investment. After slowing for five consecutive years, retail sales grew by 9.7 percent, up from 6.8 percent growth in 1999. A combination of fiscal stimulus packages and a recovery in private investment led to 9.3 percent expansion in 2000 in domestic fixed investment. An accommodative monetary policy boosted domestic demand: the prime lending rate was 5.9 percent from June 1999, compared with 11 percent in mid-1996. Since June 1999, the domestic bank lending rate has been lower than the comparable rate on dollar-denominated assets in the international market.

The deflationary trend of the previous two years was largely arrested in 2000: the consumer price index increased by 0.4 percent. However, excluding oil-related goods and one-time price adjustments for some service products, the index declined slightly in 2000, mainly because of lower prices for agricultural products.

The official estimate of urban unemployment in 2000 was about 3.1 percent of the urban labor force, the same level as in the previous year. However, this estimate covers only those registered with the Ministry of Labor and Social Security. It does not include about 7 million xiagang workers (i.e., those who were laid off as part of ongoing SOE reforms) who have not found alternative employment. When xiagang workers are included, urban unemployment rises to about 7 percent.

Fiscal policy in 2000 remained expansionary (see Figure 2.7). An additional Y50 billion stimulus package was announced in August 2000. Revenue collection was 16.9 per-cent higher than in 1999 because of improved performance in industry, recent fiscal reform measures including those against smuggling, and strong growth of external trade. Despite this, the fiscal deficit in 2000 widened to 2.8 percent of GDP compared with 2.1 percent in 1999. Broad money supply grew by 12.3 percent in 2000, slightly lower than in 1999.

To prepare the economy for membership of the World Trade Organization (WTO), the People's Bank of China, the central bank, is considering mechanisms to gradually allow a greater role for market forces in determining interest rates. As a first step, interest rates on foreign currency loans and foreign currency deposits of more than $1 million were liberalized in the third quarter of 2000.

With the recovery of the countries affected by the Asian financial crisis and strong growth in the US economy, exports from the People's Republic of China (PRC) surged in 2000 by 27.8 percent to $249 billion. Imports soared by 36.8 percent to $217 billion. Exports to the Russian Federation, the Republic of Korea, and countries of the Association of Southeast Asian Nations grew by over 40 percent. Imports of primary products, such as crude oil, metal, wood, timber, and paper, increased by 82 percent. The current account surplus in 2000 amounted to $14 billion or 1.5 percent of GDP, compared with $15.6 billion or 1.6 percent of GDP in 1999.

Actual foreign direct investment increased by 4 percent in 2000, while contracted foreign investment rose by 51 percent. With foreign exchange reserves of $165 billion and an external debt of $156 billion, the external payments situation remained comfortable.

Driven by domestic consumption growth, the economy is forecast to maintain annual GDP growth of 7.3 percent and 7.5 percent in 2001 and 2002, respectively. Both the industry and services sectors should grow at about 8 percent in this period, and the agriculture sector at about 3 percent. Domestic consumption is projected to remain strong as the general domestic economic environment improves. With the pickup in domestic consumption and economic growth, the deflationary trend in prices will be reversed. Furthermore, the impact of rising world oil prices will push up production costs. In addtion, food prices may rise slightly in the first half of 2001 because of the reduction in grain production in the second half of 2000. Given significant excess capacity in many industries, including several consumer industries, the net result is that inflation is likely to be about 2-2.5 percent in 2001-2002. Urban unemployment could further rise as more workers are laid off as SOE reforms continue.

Export growth is forecast to decline to about 10-15 percent in 2001-2002, reflecting a slower global economy and the high base of 2000. With the PRC's entry into WTO and the liberalization of trade policies, including fewer tariff and nontariff barriers, imports will continue to grow faster than exports in the next few years. As a result, the current account surplus will gradually decline. However, the fall in the current account surplus will be offset by larger inflows of foreign investment, as the Government further opens up the economy to foreign participation. Consequently it is expected that the PRC will have an overall balance-of-payments surplus of about $10 billion-$12 billion in the next two years. Some of this surplus will be used to build up foreign exchange reserves. Therefore, despite a reduction in the current account surplus, official foreign exchange reserves will have increased to nearly $185 billion by the end of 2002. It is projected that this level of reserves should be sufficient to cover eight months of imports, the entire external debt, and several times the level of short-term external debt. The exchange rate is expected to remain stable over the next two years.

Issues in Economic Management

In the aftermath of the Asian financial crisis, the Government followed an expansionary fiscal policy. Fiscal stimulus packages totaling Y360 billion were used to increase investment in infrastructure and pump-prime growth in 1997-1999. As a result, the fiscal deficit rose from 0.8 percent of GDP in 1996 to 2.1 percent in 1999. While the fiscal deficit in 2000 was 2.8 percent of GDP, it does not give a full picture of potential fiscal vulnerability, as it does not take into account:

1. the quasi-fiscal expenditures needed to resolve the problem of non-performing loans (NPLs) of the state-owned banks and the recapitalization of those banks,
2. the unfunded pension liabilities of the Government, and
3. the expenditures necessary to finance social security obligations.

Some estimates show that, if these quasi-fiscal expenditures had been included, the public sector deficit in 2000 would have been about 8 percent of GDP. The fiscal implications of resolving the legacy of the NPLs and reforming the social security system suggest that the public sector deficit may increase to about 10 percent of GDP by 2003. Therefore, further improvement of fiscal management will be required to make the fiscal balance sustainable. This is a challenging task, especially since government expenditures, as a percentage of GDP, have grown faster than revenues in recent years.

While the world oil price increases in 2000 had some negative impact on the PRC's economic growth and balance of payments, the magnitude much less than in other Asian economies. The ratio of net oil imports to domestic oil consumption was about 22 percent in the PRC compared with 55 percent in Thailand, 60 percent in the Philippines, and 100 percent in Japan. The PRC has been a net oil importer since the early 1990s. Its net oil import bill in dollar terms doubled in 2000 from the 1999 level, and may rise further in 2001. To reduce the burden on state finances, domestic fuel prices were increased on seven different occasions since November 1998, and the Government has since decided to adjust fuel prices every month. In the future, the economy will become heavily dependent on imported oil. Its demand for crude oil is projected to grow annually by 4 percent in the next decade, while the ratio of domestic supply to its total demand for oil, including refined products, is forecast to fall from the present 78 percent or so to 71 percent in 2010 and to 62 percent in 2020. Unless the economy can improve its energy efficiency, develop new domestic supplies, and diversify to other energy sources, oil imports will eventually become a heavy burden on the balance of payments.

Policy and Development Issues

Issues that the Government must resolve in the coming years include strengthening the financial system, addressing urban poverty, adjusting the economy to WTO rules, and reducing income disparities between regions. The establishment of four asset management companies (AMCs) to resolve the problem of NPLs in the banking system in 1999 was a major milestone in financial sector reform. About Y1.3 trillion ($157 billion) of NPLs, equivalent to about 10 percent of the total assets of the four big state-owned commercial banks, were transferred to the AMCs by June 2000. Most often, the AMCs used debt-equity swaps to resolve the NPL problem, signing contracts worth about Y200 billion, an amount equivalent to about 15 percent of the total assets of the AMCs, with 228 enterprises. Many of the problems in the financial sector that are related to ailing SOEs account for a large portion of bank NPLs. Two of the most difficult SOE reform issues are developing alternative methods to provide social security services traditionally provided by SOEs and generating employment for workers made redundant by SOE reforms.

While the transfer of a significant proportion of NPLs to AMCs will improve the financial position of the banks, the ultimate success of the AMCs will depend on the rate of recovery from NPLs. For the AMC initiative to succeed, debt-equity swaps must be accompanied by meaningful enterprise restructuring. This will require (i) providing legal powers to the AMCs to restructure the management and operations of the enterprises in which they become stakeholders, including the ability to replace managers when necessary; and (ii) enhancing creditors' rights by revising the bankruptcy law and establishing procedures for the valuation and disposal of state assets.

The Government has made significant efforts to restructure many nonbank financial institutions. However, as the proportion of NPLs held by these institutions becomes greater than that held by the banks, the Government must increasingly address their NPL problem so that systemic risks will not be transmitted to the rest of the financial sector.

The PRC's accession to WTO and its associated commitments to cut tariffs, liberalize trade and investment, and open domestic sectors to foreign participation will lead to significant efficiency gains, more competition, and wider consumer choice. However, some of these benefits will take time to make themselves felt. During the early years, membership in WTO will pose several challenges, including substantial structural adjustment across a wide range of sectors (e.g., agriculture, automobiles, banking, insurance, and telecommunications). The Government has amended three laws relating to foreign investment (on foreign joint ventures, foreign cooperatives, and wholly owned foreign ventures) in preparation for WTO entry. These changes will generally help foreign firms compete equally with domestic companies. The Government is also committed to revising over 1,000 laws and regulations, including a patent law, to make them consistent with WTO rules.

As a result both of redundancies among workers and rural-urban migration, urban unemployment and urban poverty increased in the second half of the 1990s. The Government has responded to rising urban unemployment by facilitating job creation through promoting the private sector, especially small and medium-sized enterprises (SMEs), and by initiating reforms of the social security system to establish a social safety net. It has also adopted measures to create a more favorable environment for the private sector, including amending the constitution in March 1999 to give greater legal status to the private sector. The Government has passed several economic laws to develop the type of legal and regulatory framework required for the efficient functioning of a market economy. It has also sought to improve SME access to credit by setting up credit guarantee schemes in more than 70 cities. Commercial banks have been requested to establish SME departments to improve their services to these enterprises. In addition, the Government has initiated a social security reform program to reduce the social costs of SOE reform, the key objectives of which are to help transform the existing arrangements into a multifaceted and financially sustainable system, broaden coverage, and establish an enabling environment that will support the long-term viability of the system. Starting in 2001, a large-scale pilot project on social security reform will be implemented in Liaoning province and in several cities. A minimum living standards support system for urban residents has also been established to help those in urban areas with incomes below the poverty line.

Box 2.3 Role of the Private Sector in Economic Development in the People’s Republic of China The emergence of a significant private sector in the People’s Republic of China is one of the most important aspects of the market-oriented reforms in the past 20 years. The domestic private sector (including domestic private enterprises and self-employed individuals) accounted for at least 13 percent of PRC’s GDP in 1998. If a broader concept is used—including companies listed on stock exchanges, joint ventures with foreign participation, private agriculture, and nominal collective companies, which are collective in name but truly private companies—the private sector accounted for 50 percent of GDP. Private sector development has helped the economy absorb a growing component of the labor force. Since 1994, the domestic private sector has taken in an average of 8.2 million workers every year. Aside from joint ventures with foreign participation, the domestic private sector is the only sector that has provided jobs to unemployed workers from state-owned enterprises and redundant rural laborers in the past five years. The sector currently employs 83 million people, or 12 percent of the workforce, which is equivalent to the number employed by the Government and state-owned enterprises. Private sector development has also had a significant impact on poverty reduction. Provinces and cities that have a high share of private sector activity usually have much lower poverty. A recent unpublished Asian Development Bank study shows that the relationship between per capita GDP and the share of private sector employment in total employment in 30 provinces clearly indicates the contribution of private sector employment to the level of income (see box figure). On average among provinces, for every 1 percent increase in the share of private employment, there is a corresponding increase of Y164 ($20) in per capita GDP. In spite of the rapid development of the last two decades, the general environment for the private sector needs to be further improved: market distortions, strict regulations, limited access to finance and public service, and high operating costs due to rent seeking and bureaucratic procedures of some local governments should be removed. General weaknesses of governance and transparency of private firm operations are also apparent. The Government needs to overcome these constraints.

Coupled with the Government's antipoverty programs, sustained economic growth and macroeconomic stability have helped reduce poverty. The number of rural people with incomes below the official poverty line declined from 42 million (4.8 percent of the rural population) in 1998 to 34 million (3.8 percent of the rural population) in 1999. The number of rural poor declined further to about 26 million (3.1 percent of the rural population) in 2000. However, the official poverty estimate is based on a very low annual income, which is just enough to meet basic food and clothing requirements. Also, the Government's poverty data do not cover urban areas. Estimates of poverty levels based on internationally comparable norms and covering both rural and urban areas are much higher. About 230 million people (18.5 percent of the population) still live below the $1-a-day poverty level (based on per capita consumption norms at 1985 purchasing power parity rates). The incidence of poverty in the interior provinces is much higher than the national average, especially in the western regions. Education and health conditions in the interior provinces are also far below the national average. In addition, roughly half the children in households at or below the poverty line are at least mildly malnourished.

In the past 20 years or so of reform, substantial disparities in regional living standards have emerged. Per capita GDP in the western regions is about two thirds of the national average and only one third of that in the coastal regions. The Government has, in fact, made efforts to promote development in the poorer interior provinces. The March 2000 session of the National People's Congress endorsed the "go west" policy, a proactive policy to promote growth and development in the western regions. It is a priority in the Tenth Five-Year Plan. Developing infrastructure, both physical and social, and improving natural resource management constitute the core of the policy. The Government has also announced a package of preferential measures to facilitate development in the western regions, including:

1. raising the central Government's budget allocation for large-scale projects in these regions and increasing fiscal transfers to them for social development;
2. allocating the central Government's poverty reduction funds mainly to these regions;
3. encouraging international financial organizations, bilateral agencies, and state banks to invest more in the western regions;
4. encouraging economic cooperation of these regions with neighboring countries;
5. giving foreign-funded firms participating in the economic development of the western regions the same preferential policies as those in the coastal economic zones; and
6. encouraging foreign-funded enterprises in the coastal areas to reinvest profits in the western regions.

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