The Chinese Economy

ECON 522 Ahmed Alabbadi Pei Yu Shih (Jennifer) Salah Alsayaary The ChineseEconomy

Miraculous Growth:Asian Paradigm for Development • Competitive (Cheap) Unemployed Labor Absorbed into Manufactured Sector

Growth in GDPUSD (Billions) 85-05 (14%) 06-10 (8%)

Why,… • China’s economy grew at 10.2% in the 1st Q in 2006 (highest record since 2003) • Investment-led growth (easy lending from Chinese banks) • Export-led growth (undervalued Chinese currency), →↑demand for Chinese goods & export →↓demand for US’s goods & export →↑US trade deficit with China

Also, Why,…. • More rapid output and productivity growth in agriculture • Higher rate of growth of manufactured exports • Creation of a business-friendly environment : legal and regulatory structure that was generally hospitable to private investment • The building and growing of human capital • Increasing of savings and investments • Higher growth rate in physical capital with higher rates of domestic savings • Declining income inequality • The openness to foreign technology • Promoting specific industries

Foreign Investment • Rapidly increasing foreign investment since entry to WTO • China experienced an increase of 22.55% in foreign direct investment one year after WTO entry • The largest foreign investment destination in the world • Low cost labor and vast market created more profits

WTO Impact on Economy • GDP grew by 7.9% the following year after entering WTO • Increase of 18.4% in trade volume with the United States after one year • China’s exports increased by 19.7% after one year • China became the 4th largest trade body in the world behind only the United States, EU and Japan

Fiscal Reforms • No market price, no market economy • Price policy reform First phase (1978 -1984) • No market pricing mechanism • Government raised prices of good in shortage and decreases prices of good in surplus • Decrease the differences between planed prices and market prices Second phase (1985-) • Gradually allow market pricing • Dual-track price system;Prices of goods within the state plan were controlled while prices outside the state plan are decided by the market • By 1996, 93% of retail goods, 79% of agricultural goods, 81% of production factors were priced by markets

Fiscal Reforms and Work • Replacement of appropriating profits with taxing profits -- 1983 – 1984 • Fiscal contracting with the provinces -- mid-1980s • Division of the tax-collection system -- two-tier tax collection system -- 1994 Chinese government: • Address its trade surplus by ↑imports and domestic demand ,↓export tax rebates. • Integrate corporate taxes paid by F and D firms • ↑Interest rates

The Current Account • Chinese accession to the WTO is likely to increase imports more than exports in the short and intermediate runs, thus resulting in an eventual decrease in its net trade surplus. • Rapid increases in oil imports also foreshadow a significant narrowing of the trade surplus in the future. • China has net inflows of foreign direct investment of approximately US$52.7 billion a year. • Errors & Omissions, normally a large negative item, reflecting capital flight and other leakages have been declining in absolute magnitude very rapidly. • It appeared that China can, at this time, afford to run a current account deficit -- avoid an over-accumulation of foreign exchange reserves, -- lower domestic money supply -- reduce external pressure to appreciate the currency. • A stable exchange rate also requires stable expectations, which in turn depends on the ratio of short-term liquid and liquefiable liabilities to foreign reserves.

China’s Economy Monetary Policy

Monetary Policy Instruments • Open Market Operations (OMO) • Reserve Requirements Ratio (RRR) • Interest rates controls • Window guidance

Required Reserves Ratiosource : the PBC

Reserve Requirements Ratio (RRR)

Interest rate movements

Monetary Policy Instruments

China’s Economy Inflation

Inflation Source:IMF(Apr. 07)

InflationSource:IMF(Apr. 07)

Exchange Rate Policy

Asian Financial Crisis • A period of economic unrest that started in July 1997 in Thailand and South Korea. • China, Japan, Taiwan, Singapore, and Vietnam were relatively unaffected. • All nations affected by the crisis saw their currencies dip significantly relative to US dollar, though the hardest hit nations saw extended currency losses.

The cause of Asian Financial Crisis • Inflow of short-term capital like hedge funds • Long-term high growth of economies • Imprudent borrowing and lending, especially from abroad • Prevailing optimistic expectation • Pegged exchange rate

The cause of Asian Financial Crisis • The deterioration of Japanese economy • A weak financial sector together with quick liberalization of the capital markets • A slow reflection to the crisis from the US government • The region and the world as a whole become highly integrated and interdependent

Why China can avoid the crisis • The early cooling down --Control the banking lending and restructure bad loans -- Recognize the soft-landing before the financial crisis • No debt crisis -- A healthy structure of capital inflow -- Gradual opening of the financial market -- Positive trade balance to pay debts

Why China can avoid the crisis • Effective measures -- Increase capital-debt ratio of major state banks to 8% -- Re-centralize the control of foreign borrowing -- Strengthen the evaluation and monitoring of listed companies • Chinese Yuan is stable -- Moved to unified market rate after 1994 -- Healthy fundamentals and positive trade balance -- Not fully opened capital market

Capital Control • The successful launch of the QFII scheme • Less exchange rate flexibility • Less opened capital markets • Sterilize intervention • Ease restrictions on selected capital outflows • Tighten inward portfolio investment

The End • Thank you

The Chinese Economy