China's policy changes in the last decade

China Information News
China's policy changes in the last decade
21 November 2008

A recent State Council executive meeting has decided that China now should implement a proactive fiscal policy and a moderately loose monetary policy, and define further measures to boost domestic demand so as to maintain a steady and relatively rapid economic growth. It was also agreed at the meeting that in the past 2 months the worldwide economic and financial crisis has steadily worsened, and a flexible and prudent macroeconomic policy is needed to cope with the complexity of the situation and avoid adverse economic impact.

This is the first time in the past 10 years that the Chinese government has decided to implement a moderately loose monetary policy, and it represents a significant policy change. At the same time, fiscal policy is to be changed from "prudent" to "proactive."

Shenyin & Wanguo Securities macro-economic analyst Li Huiyong says the adjustment of both monetary and fiscal policies means the expansion of macro control. Maintaining steady and relatively rapid economic growth has definitely become the main target of domestic macro control over the next few years.

In 1995, to cope with the financial crisis in Asia, the Chinese government decided to implement a prudent monetary policy and a proactive fiscal policy. The move laid an important foundation for maintaining domestic economic growth and resisting the financial crisis. This policy combination continued till 2004.

At the end of 2004, the Central Economic Working Conference decided to implement "prudent fiscal and monetary policies" in order to control the excessive growth of fixed asset investment and adjust relationships between investment and consumption. The conference urged that a principle of dealing individually with different sectors should be followed when implementing macro policy measures. This policy combination continued till 2007.

At the end of 2007, the Central Economic Working Conference decided to implement "prudent fiscal policy and tight monetary policy" in order to prevent the rapidly-growing economy from overheating, and to keep structural price rises from turning into significant inflation.

However, monetary policy is no longer "tight" or "moderately tight" as the financial crisis spreads in the second half of 2008. According to public information, since September the People’s Bank of China (PBC) has cut rates 3 times in 2 months, reduced the reserve ratio twice, and reduced public market operations. The central bank no longer lays rigid constraints on bank credit and loans.

China International Capital Corporation (CICC) chief economist Ha Jiming says the effect of the "moderately loose monetary policy" may be more powerful than the "prudent monetary policy" of 1998. The policy combination will definitely boost market confidence.

A prudent move by the Chinese government

The State Council executive meeting approved 10 measures to boost domestic demand and promote economic growth. The meeting said projects provided for within the 10 measures involve 4000 billion yuan of investment up to the end of 2010. To accelerate the progress of construction, the meeting also decided that 100 billion yuan of central investment will be added in the fourth quarter of this year, and 20 billion yuan investment will be earmarked for reconstruction in quake-hit areas next year.

Judging from the announced policy measures, the economic steps taken by the Chinese government are much bigger than those taken 10 years ago to deal with the Asian financial crisis, says Peng Xingyun, a researcher at the Institute of Finance and Banking under the Chinese Academy of Social Sciences (CASS). In dealing with the Asian financial crisis China increased its issue of treasury bonds but did not specify the volume of investment. This time the situation is different – the government has defined target sectors for investment, and also the volume of funds to be invested.

Ba Shusong, researcher with the State Council Development Research Center, says the policy changes reflect that in a more open environment China’s economy is more prone to be influenced by external factors than it was during the Asian financial crisis in 1998. This is not only because of a higher rate of capital flow and foreign exchange reserves, but also the greater degree of dependence on exports. Statistics show that China’s export dependency ratio was 18 percent, but that percentage had risen to 38 by 2007.

Previous media reports show that Chinese exports to the US have fallen since the outbreak of the subprime crisis, although a rise of exports to Europe has compensated. Nevertheless, the yuan is now rising quickly against the euro, and the European economy is showing signs of weakness. A decline in exports can be predicted in 2009. All of these factors will provide challenges to future economic growth.

Another reason for the change in policy combination is the rapid downturn in macroeconomic growth. Statistics show that GDP growth in the second quarter of 2007 was 12.2 percent, while in the third quarter of 2008 GDP growth had fallen to 9 percent. As a result of an economic boost from the Olympics and policy packages designed to spur economic growth the fourth quarter GDP figure may rise, but the general trend in GDP growth is downwards.

To prevent an excessive economic slowdown, the Chinese government has announced 10 policy measures to boost domestic demand and promote economic growth. Ba Shusong said the stimulus is a prudent move by the Chinese government when its economy is facing three-fold pressure. The subprime crisis, a cyclical fall-back after 8 years of rapid economic growth, and economic restructuring after 30 years of reform and opening-up, are all challenges to China's future economic growth.

The influence of the Subprime crisis provides China with an opportunity to enact more comprehensive reforms

Ba Shusong says that although the country faces economic challenges, China is in a favorable position compared with the situation during the Asian financial crisis in 1998, taking into account such factors as greater national strength, more abundant foreign exchange reserves, and stronger fiscal resources and currency.

Li Huiyong's analysis indicates that the increase of fiscal expenditure will have a short-term impact by stimulating investment and promoting economic growth. According to the State Council, 120 billion yuan will be added to fourth-quarter fiscal investment. The total volume of investment may reach 400 billion yuan taking into account its multiplier effect. The move will push fixed-asset investments to grow by 10 percent. Fixed-asset investment growth in the fourth-quarter will probably be 26 percent or more. GDP growth is expected to be more than 9 percent.

What is encouraging is that every external factor impacting on China's economy will ultimately represent an important opportunity for China to mobilize resources, promote structural reforms of the economic system, and tap new sources of economic growth.

Ba Shusong recalls that China carried out a series of reforms in dealing with financial crisis in 1998, including reforms of state-owned enterprise, the housing system and state-owned banks. These reforms laid a solid foundation for the integration of China into the global economy. "Similarly, the influence of the subprime crisis will provide China with a chance to implement more comprehensive reforms," he says.

Ba Shusong suggests government departments should also adopt the following measures:

First, boosting domestic demand should be the major policy measure to deal with the subprime crisis, in particular by further improving the social security system, adjusting the national income distribution structure, lowering taxes, and priming the rural economy. Effective action should be taken to reverse the rapid downward trend of the housing and auto markets.

Second, enact reform of industrial infrastructure and ease bureaucratic restrictions and controls on industry to lure and encourage more private investment.

Third, promote the development of service industries. Although China's economy is growing fast, with a GDP figure of 9 percent, people are still worried about their job prospects, which is largely a reflection of the problems existing in investment and productive structures and the economic growth model. The development of service industries which can absorb quantities of labor is lagging. The government should consider reducing administrative restrictions on sectors such as banking, insurance, medical services, and education, and giving private capital equal status in accordance with the relevant WTO regulations.

Since the stimulant effect of fiscal policy will have more impact in the current economic situation, Jia Kang, director of the Research Institute for Fiscal Science of the Ministry of Finance, says that VAT reform alone is not enough. He suggests that the threshold for personal income tax should be raised, and that development of new products and application of new technology and techniques should benefit from preferential tax policies. Furthermore, the government can issue long-term treasury bonds for construction to boost infrastructure projects.

(China.org.cn by Zhang Yunxing, November 21, 2008)