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The Global Financial Crisis has had a profound impact on many advanced and emerging economies, leaving very few left unscathed. As one of the key world economic engines, China was also impacted and played a role in stabilizing the world economy. This report will give a macroeconomic overview of China during the onset of the GFC, the impact on it, and the future outlook as it recovers from the crisis.
Since the launch of the reform and opening policies in 1978, China has achieved unprecedented levels of GDP growth averaging 10% in the past 30 years. Its best macroeconomic performance was between 2002-2007 when it achieved an average annual growth of 10.5%. GDP growth in 2007 was 13% before the GFC.
Figure 1 - China GDP Growth
The main driver of China's economic growth has been fixed-asset investment and exports In 2007, exports were booming as China become the largest exporter and second largest importer of goods. The result was a current account of USD 371.8 billion. Foreign reserves the trillion mark at the end of 2006 and therefore surpassed Japan as the country with the largest foreign reservers.
The contribution of domestic consumption to GDP remains low as households maintain high savings rate at an average of 40% (Zweig, 2008). However, it is increasing rapidly. Between 2007-2008, domestic consumption increased from 41% to 46% of GDP growth and this is considered key to China's growth.
Figure 2 - Domestic Consumption in China
After China's accession to the WTO in 2001, the Yuan slowly began appreciating as new markets opened to China (Crosby, Nov 2009). China fixed its exchange rate to US dollars at 8.28RMB per US dollar. From July, 2005, China has allowed RMB to vary against a weighted basket of currencies and RMB has appreciated to around RMB 6.28 per U.S. dollar over the last 5 years.
Official unemployment figures by the government estimate unemployment at around 4% between 2005-2008. However, actual unemployment might be higher as certain sources are not captured in the calculation of these figures.
China's major economic concern before the GFC was an overheating of the economy, overcapacity, real state speculation, and inflation (driven by strong domestic and foreign demand). Inflation was kept at around 2% between 2002-2007. However, inflation rose to about 7% in 2007-2008. Food and fuel were major problem areas. There were various reasons behind such as shortage of gasoline The economy was overheating and there were high levels of speculation in booming asset markets. In response, the People's Bank of China which formulates and implements monetary policy under the supervision of the State Council, increased banks reserve requirement ratio and interest rates to rein in bank credit and domestic demand. In addition, interest rates were also continuously on the rise to curb inflation. In fact between 2006-2007, it raised three times (New York Times, 2007). (Need to get more recent data, 2007-2008)
In terms of fiscal policy, China was in a good condition. Government revenues and spending were increasing. In 2007, there was a budget surplus of 20.3 billion. Prior to that, there were budget deficits between 26-39 billion annually. The government also kept a low public debt to GDP ratio of around 17% since 2003.
Overall, the Chinese economy was continuing to experience its strong levels of growth with no indications of a slowdown prior to the GFC.
GFC and China
The Global Financial Crisis has had a profound impact on China. In the first quarter of 2009, GDP growth fell to 6.1% which was one of the poorest quarterly performances for the country in recent years. There was a massive decrease in exports and foreign direct investment, two of the biggest drivers of GDP growth in recent years. The export-oriented light industry in Southern China was heavily hit with thousands of companies closing down, and thousands workers laid off. Growth Rate of exports fell from 20% to -2.2 (Need to elaborate and insert chart)
Unemployment was also problematic as over 20 million people consisting mostly migrant workers lost their jobs since the manufacturing industry was especially hard hit. Furthermore, there were also approximately 6 million undergraduates seeking jobs. This was especially problematic for the government because of the fear that high unemployment could lead to social unrest across the country. The official unemployment figure released by the Chinese government for 2008 was 4.2%. However, there were many company closures in the 4th quarter of 2008 and this does not seem to be accounted for.
In the financial sector, the Shanghai composite index stock market value was wiped out by two-thirds. Many of the western banks which had investments in Chinese banks sold their stakes in them to get more capital. Furthermore, the China Investment Corporation (CIC), China's sovereign wealth fund incurred huge losses through its heavy investments in western companies such as Lehman brothers. This sparked public outrage.
One of the heavy hit industries was the steel industry. This industry is one of China's key industries and globally it is the world's largest steel producer driven by increasing demands for rapid urbanization and many large-scale infrastructure projects. (Need numbers indicating how it was hard hit, decrease in exports? Overcapacity...etc)
On the commodities side, as prices for commodities collapsed around the world, China took advantage of the drop in prices to stockpile commodities including oil, copper, coal.
(Need more information about commodities during the crisis in relation to China's own commodities)
With the global downturn threatening stability of the Chinese economy, the Chinese government used a combination of active fiscal policy and moderately loose monetary policy to maintain growth.
The communist government is extremely conscious of maintaining a sufficient level of economic growth to preserve social stability in the country and maintain its regime legitimacy. In 1998 during the Asian Financial Crisis, China responded by driving domestic demand to compensate for the fall in exports and upkeep GDP growth at 8%. Similarly, the Chinese government set a goal of 8% GDP growth for the third quarter of 2009. The fiscal response included a massive stimulus package as well as tax rebates for suffering industries.
On November 18, 2008, Premier Wen Jia Bao announced a $586 billion stimulus package (approximately 13.4 percent of GDP in 2008) to stimulate GDP growth through 2010. It focuses on increasing both investment and consumption through a combination of public works, subsidies and tax reform. In addition, with unemployment on the rise during the crisis, large infrastructure projects can alleviate unemployment, especially among migrants workers.
The government also identified 10 major industries vital for growth . These industries include: auto, steel, shipbuilding, textiles, machinery, electronics and information, light industry, petrochemicals, non-ferrous metals, and logistics. These industries were supported by government policies that included tax cuts, export tax rebates, industry subsidies.
Other fiscal responses included individuals no longer having to need to pay tax on interest savings and interest income earned from stock account balances. Minimum down payment for first-time home buyers was reduced to 20 percent from 30 percent of the purchase price.
In terms of monetary policy, the Chinese government implemented an expansionary monetary policy by cutting interest rates and boosting bank lending and money supply. The Chinese central bank cut interest rates 5 times from September to December 2008. The banking system in China is still develop and hence it capital is not allocated efficiently. Large corporations can borrow much more easily than SME's and also not need to worry about returns which could possibly lead to speculation in property and shares, as well as an increase in the number of non-performing loans, issues which they were trying to remedy at the onset of the crisis. Hence, monetary policy is a very delicate matter for the Chinese government.
At the onset of the GFC in July 2008, the People's Central Bank of China, froze the yuan's exchange rate at approximately 6.83 RMB to the US dollar and did not let it appreciate during the financial crisis. Weighted mostly to the US Dollar, China's basket of currencies is also composed of currency from the EU, Japan, Korea, Singapore, the U.K., Malaysia, Russia, Australia, Canada and Thailand. The exact composition is known only to China. (Back, 2010) The purpose of the freeze is to increase Chinese manufacturer's ability to compete globally amid weak demand during the GFC (Associated Press 2010).
Road to Recovery
China has navigated itself through the financial crisis quite well and has remained relatively unscathed. It was among the few nations to achieve growth during crisis and the best among the G20 countries due to the quick fiscal and monetary responses which increased public investment and raised consumption . China's economy achieved an overall rebound and recovery, with annual GDP growth of 8.7 percent and fourth quarter growth of 10.7 percent in 2009
GDP growth is expected to accelerate to 10 percent in 2010. In Q2 of 2010, GDP growth reached 10.3%. The contribution from investment is expected to remain high, though substantially below that in 2009, as the pace of new public and private investment moderates, largely reflecting tightening measures to prevent overheating. Buoyed by ongoing structural reforms and fiscal measures, consumption growth should remain relatively robust, while the recovery in external demand implies that net exports would no longer subtract from growth. Rapid growth is projected to continue in 2011 but will be driven more by the private sector, with an increase in private investment offsetting falling public investment levels, and with the contribution of external demand turning positive again. Inflation is modest and fell to 2.9 percent in June 2010 from 3.1 percent in May.
Households still not spending credit (World Bank, 2010). Interest rates remain low due to the central bank's policy flexibility and control of local government investments. Low interest rates and ample liquidity continue to boost the economy. (World Bank, 2010) This creates concern for over-investments and real estate speculation.
China will maintain the continuity and stability of macroeconomic policy, and make
more targeted and flexible policies to respond to new developments. In particular, China will properly balance the need for maintaining steady and relatively rapid growth in the economy, adjusting economic structures, and managing inflationary expectations. China will continue to implement a proactive fiscal policy and a relatively easy monetary policy, and will continuously improve the policy package to respond to the international financial crisis to maintain good momentum of the economic recovery. China will accelerate the transformation of the economic development model, adjust and optimize the structure of the economy, aggressively expand domestic consumption demand, focusing efforts on improving the investment structure and facilitating sustainable growth driven by endogenous forces such as innovation. China will use a variety of monetary and fiscal policy tools, pay close attention to price trends.
Unemployment, overcapacity, and exchange rates, and remain major issues. In June of 2010, shortly before the G20 Summit, China announced they will unfreeze the Yuan. Because small appreciation is predicted, the change from the CBC is viewed more as a political move than an actual move to stabilize the global economy. (Associated Press 2010) Unemployment remains a challenging problem as millions of university students graduate each year and will need to be addressed to preserve social stability. Rebalancing the economy and driving domestic consumption will be key to future growth.
Despite the complexities and challenges facing the Chinese economy, high levels of growth are predicted to continue into the future and it remains on track to overtake Japan as the world's second largest economy this year.