G-20: Implications on China

1. G-20: Implications on China Prepared for: The School of International Business Administration (SIBA) at Shanghai University of Finance and Economics (SHUFE) By Maria Monica Wihardja Centre for Strategic and International Studies

2. History of the G20 • G20: “extension of G7” • Evolution: • 1975 Library Group: senior officials of France, Japan, U.K., U.S., W. Germany needed a forum for major industrial economies • Adoption of floating exchange rates in early 1970s • Oil crisis in 1973 • 1975 G-6 Summit: France invited and agreed on annual summits • Include Italy • 1976 G-7 Summit: economic policy coordination group • Include Canada • Make up 70% of world GDP and 15% of world population

3. Evolution (cont): • 1997 G-8 Summit • Include the Russian Federation • Centrally planned economies collapsed (1989 East Germany, 1991 USSR), economic and political landscape changed • 1999 G-20 Summit • East Asian financial crisis 1997-1998, Russian crisis 1998 • G-8 started losing legitimacy for solving the global problems • Emerging economies were excluded from global economic discussion • New global challenges appeared (HIV/AID, global warming, etc.) • However, G-8 remained to be the major economic forum until 2008 • G-8 started losing legitimacy for overcoming the 2008 global crisis.

4. Global Financial Crisis 2008/2009 • G-20 became the Premier Global Economic Forum in 2008: • G-20: November 2008, Washington, D.C. • Consider cooperative efforts to cope with the crisis • Consider financial regulatory reform and international monetary system reform to avoid future crisis • Lay foundations for restoring economic growth • Key policy coordination forum • Help avert a global meltdown (or another great depression) • Coordinated central banks’ financial rescues and rapid liquidity injection (w/ IFIs, EU) • Coordinated fiscal packages’ enhancement of aggregate demand and social protection • Avoid trade protectionism

5. Members of the G-20 • Africa: South Africa • North America: Canada, United States • Latin America: Argentina, Brazil, Mexico, • East Asia: China, Japan, South Korea • South Asia: India • South East Asia: Indonesia • Western Asia: Saudi Arabia • Europe: European Union, France, Germany, Italy, Russia, Turkey, United Kingdom • Oceania: Australia

7. Development of the G-20 (2009-2012) • 2009 G-20 Summit, Pittsburgh: • G-20 recognized as “the premier of global economic forum” • Framework of Strong, Sustainable and Balanced Growth (FSSBG) • Raise living standards in emerging and DCs • 2010 G-20 Summit, Toronto: • Addressed issues on employment and poverty (long-term issues) • Narrowing development gap and reducing poverty rate integral to “strong, sustainable and balanced growth” • Structural reform as the tools for long-term economic reforms • 2010 G-20 Summit in Seoul adopted development as the major item of the agenda • Agreed on Seoul Development Consensus for Shared Growth + Multi-year Action Plan+ Financial inclusion action plan • Development policy options and priorities • As a complement MDGs

8. 2011 G-20, Cannes: • Crisis picking-up with no immediate solution • Endorsed the Action Plan on Growth and Jobs • Endorsed the Action Plan on Food Price Volatility and Agriculture • Endorsed Green Climate Fund • Formalized Troika, consisting of past, present and future Presidencies

9. 2012 G-20 Summit, Los Cabos: • The first time that a developing country hosted a G-20 Summit • The world was still in the downside-risk of a crisis • Endorsed the Los CabosGrowth and Jobs Action Plan, balancing growth-job with austerity and fiscal consolidation • Promoted Inclusive Green Growth as an integral part of FSSBG • Food security and commodity and energy price volatility • Financial Inclusion Peer Learning Program (with Chile and Indonesia) • IMF raised US$456 billion for its “second-line of defense”, with China contributing US$43 billion (EMs to push for the 2010 IMF quota and voting reform) • Tremendous each-out activities: B-20, Think 20, L-20, Youth -20 • CIGI report on media and public perception: • Financial regulation reform/ FSB report receive no attention in the 11 G20 capitals surveyed. • G-20 losing its focus?

10. Mutual Assessment Process:From Pittsburgh to St. Petersburg • At the 2009 G-20 Summit in Pittsburgh: • MAP was launched to evaluate the consistency of G-20 policies and frameworks with members’ share growth objectives (FSSBG) • MAP is a new approach to policy collaboration and owned by members of the G-20, with the goal to ensure that collective policy action will benefit all. • At the 2010 Summit in Seoul: • “Outlining an action-oriented plan with each member’s concrete policy commitments” • “Persistently large external imbalances, assessed against indicative guidelines… warrant an assessment of their nature and the root causes of impediments to adjustment as part of MAP…” • Three pillars: • MAP analysis • Policy progress accountability • Assessment of imbalances (by setting up indicators and indicative guidelines)

11. MAP • The first stage of the MAP: From Pittsburg (2009) to Toronto (2010) • Aggregate G-20 members’ policy and macroeconomic frameworks • Assess whether members’ policies would help achieve the G-20’s objectives and evaluate alternate policy sessions • The second stage of the MAP: From Toronto (2010) to Seoul (2010) • An enhanced MAP, with indicative guidelines for key imbalances • Policy commitments by the G-20 • The third stage of the MAP: From Seoul to Cannes • Paris Meeting (February 2011) • G-20 authorities reached agreement on the key indicators: public debt, fiscal deficits, private saving rate, private debt, and the external balance composed of the trade balance and net investment income flows and transfers • Seven systemic imbalance countries: China, India, Japan, France, Germany, UK, and US • Washington D.C. Meeting (April 2011) • G-20 authorities reached agreement on the Indicative Guidelines to identify the presence of large imbalances • In-depth analysis of large imbalances • Progress reports • Updated frameworks • The current stage of the MAP: Post-Cannes • Near-term actions • Medium-term Policy Imperatives • G-20 Los Cabos Summit • The Los Cabos Growth and Jobs Action Plan • The Los Cabos Accountability Assessment Framework • The Los Cabos Accountability Assessment (first assessment) • Policy Commitments by G-20 Members, including updates to progress reports

12. Reducing Imbalances • To achieve FSSBG, “two rebalancing act” is needed to resolve: • Internal imbalances • Focuses mainly on public finances • External imbalances • Focuses mainly current account • Internal and external imbalances are interlinked via the “S-I=NX” identity • Imbalances are NOT prima facie “bad” • They warrant remedial action only to the extent that they are underpinned by distortions • Imbalances can be beneficial if they reflect the optimal allocation of capital across time and space • Imbalances can be detrimental if they reflect structural shortcomings, policy distortions or market failures.

13. Explaining Imbalances • Sources of external imbalances in the run-up to the crisis vary widely across the seven economies • Largely reflecting factors that have led domestic saving behavior to differ widely • Country in bracket denote those with current account deficits

14. Countries with current account deficits: • Have low public and private saving (United Kingdom and United States), or • Have low public saving, which has been offset by high private saving (France and India) • Countries with current account surpluses: • Have high national saving, that exceeds high private investment (China), or • Have high national saving and low investment, which has offset high (modest) public dis-saving in the case of Japan (Germany)

15. Explaining Imbalances • A variety of structural and equilibrium factors have driven public saving behaviors • Factors underpinning fiscal deficits include: • Japan: • persistently low growth, reflecting a decline in productivity • a shrinking labor force • low investment • the needs of a rapidly aging population • France, UK, US: • Structural imbalances between tax revenues and spending commitments pre-crisis • Underfunded entitlement obligations • The lack of agreement on fiscal adjustment priorities • The lack of fiscal rules and strict enforcement mechanisms to impose sufficient budgetary discipline • India, Japan, US: • Political economy considerations exerting strong pressures on spending and resistance to raising taxes • A weak revenue system and financial repression (India)

16. Domestic policy distortions have also played an important role in driving imbalances: • Distortion in financial systems have fueled low private saving and large current account deficits • UK and US: • Regulatory and supervisory frameworks distortions were partly responsible for a fundamental breakdown in market discipline and mispricing of risk • High national saving in China reflects significant underlying distortions • China: • Inadequate social safety nets, restrictive financial conditions, and undervalued exchange rate subsidized factor costs, limited dividends and lack of competition in product markets • This in turn creates massive reserve accumulation, contributing to the low-cost financing of US current account deficit

17. Weak investment in some advanced economies also reflects policy distortions • Japan: • Private investment growth (particularly by SMEs) has remained weak, while corporate savings are large • India: • Tight financial restrictions have allowed the perpetuations of large fiscal deficits • Germany: • Distortion in the financial sector may be a drag on domestic investment

18. Policy Implication • Sustainability assessment indicate that imbalances have been driven primarily by saving imbalances • Too low in major advanced economies • Too high in key emerging surplus economies • Policies tailored to individual country circumstances are needed to facilitate the “dual rebalancing” acts and to anchor members’ growth objectives • France, Japan, UK, US • Fiscal consolidation • China • Reduce distortions that have kept saving exceptionally high • Japan and Germany • Lower corporate saving and boosting investment by reducing distortions

19. 4 Groups of the G-20:Policy Prescription

20. Structural Reform (SR) • SR have to be included as parts of the strategies in the new growth model: • “The old growth path has become unbalanced, inefficient and unsustainable because market reforms that have encouraged it are incomplete. Goods markets have been liberalized but other markets are still heavily distorted.” (Drysdale et. al., 2009) • SR can be defined as: • “Measures to improve institutions and incentives for efficient and sustainable production, investment and employment, and facilitate fundamental, productivity-increasing changes in the economic structure” • “Behind-the-border" reforms • They are medium to long-term reforms

21. Why G-20 Leaders Discussed Structural Reform? • Structural reforms are the keys to rebalance the global imbalance that some experts have argued contributed to the global financial crisis in 2008: • Huang (2010) hypothesized that the global imbalance was partly rooted in China's factor market cost distortions that artificially boosted China's export competitiveness and inflated China's current account surplus • In the West, easy credits had lowered savings and leveraged consumption, while deregulated financial market had resulted in excessive leverages of borrowing. • Excessive savings in the East Asian surplus economies had then been used to finance excessive consumption and "unfruitful" investments such as the housing market in the deficit economies in the West.

22. Why G-20 Leaders Discussed Structural Reform? Estimated reduction in potential output (in %) in many developing countries, after the 2008 crisis

23. Why G-20 Leaders Discussed Structural Reform?

24. China and the G-20: Why the G-20 is Important to China? • The G-20 offers a good opportunity for the emerging economies to play a bigger role on the world stage: • HuJintao in 2009: “As a platform with wide representative, the G-20 can help the international community to deal with the international financial crisis.” • The increasing interdependence among different domains: • Economic relations, climate change, nuclear threats, and the spread of infectious diseases • Major organizations, such as WTO, IMF, BIS, WB, and WHO, were designed for a specific domain • The requirement of execution in international affairs: • The rising importance of the spillover effects in macroeconomic and financial stability • The IMF’s unsuccessful role in the multilateral surveillance • The broader representation with efficiency: • Include almost all the systemic importance countries, both major developed and key emerging countries • The G-20 has more legitimacy than the G7/G8 and has more efficiency than the UN.

25. China’s view on the G20 • China sees the G-20 as the best way to relate to the rest of the world • It did not otherwise have a spot at the head table • China sees the G-20 as the best way to work towards a reshaping of the international order to more closely resemble a ‘shareholding’ model, away from the current model of a ‘US-owned family business’. • The world order should be established upon the principle of multilateralism since the post-cold war era • China’s diplomatic strategy: • Keeping a low profile and taking a proactive role when feasible • Generally the attitude of Chinese government towards the G-20 is positive

26. Political Benefits to China • A chance to participate in global coordination • From a passive state to a proactive state • From outside to inside • A chance to learn global governance • Emerging markets have less experience with the peer review process, which have facilitated policy coordination • A chance to represent Chinese position and build China’s external image • A way to facilitate the adjustment of domestic economic structure • External strength can help China’s domestic reforms

27. Respect Each Other’s Red Line • China does NOT support the use of real exchange rates as indicators of monitoring world economic imbalance: • Exchange rate could be one of the reasons, but not the only reason to imbalance • The optimal policy may or may not imply a reduction in the deficit or surplus

28. China’s Red Line • China does NOT support the use of international reserves as indicators of monitoring world economic imbalance: • The International reserve is a by-product of external imbalance and a result of unreasonable monetary system • Reserve accumulation can provide protection to the economy against sharp reversals in capital flows • China is not the only country that has accumulated a great amount of foreign exchange reserves • Almost two-thirds of China’s trade surplus is created by foreign investment • Its accumulation of foreign exchange reserves is a win-win outcome for both China and foreign investors • There are other countries that have maintained a trade surplus for a prolonged period of time • For instance, Germany has kept this surplus for 58 years and Japan for 29 years. China has had it only since 1997 • Technical factor matters

29. The features of China’s Old Development Model • Investment-driven: • Low commodity price, low energy and environmental cost (distorted factor prices) • Low interest rate (an implicit welfare transfer from household sector to enterprise sector) • Export-oriented: • The natural result of strong investment and weak domestic consumption • Significant undervalued RMB exchange rate • Demographic surplus (nearly infinite supply of unskilled labor)

30. The consequences of China’s old development model • The low consumption ratio and high investment ratio • Significant current account surplus • Even worse, the twin surplus (huge foreign exchange reserve accumulation) • Industry imbalance (overdeveloped manufacturing industry and underdeveloped service industry, which leads to low service consumption) • Strong SOEs and weak small and medium size private enterprises • Over-reliance on loose monetary policy (high monetized economy)

31. China’s economic growth relies heavily on investment and export Percent of GDP Source: CEIC .

32. Even compared with the high growth era of developed countries, China’s private consumption expenditure to GDP ratio is extremely low Private Consumption to GDP Ratio Source: CEIC .

33. And China’s investment to GDP ratio is extremely high Fixed Asset Formation to GDP Ratio Source: CEIC .

34. Japan, Germany and China all have a significant currency account surplus Current Account to GDP Ratio Source: IMF’s WEO .

35. China has a persistent twin surplus since 1999, and U.S.’s overall BOP is more balanced China United States Source: CEIC .

36. And the same for Japan and Germany Japan Germany Source: CEIC .

37. China is a major international creditor, but the investment income is very small if compared with other countries Overseas investment income to GDP ratio Source: IMF’s WEO.

38. The Manufacturing sector in China is very large The output of second industry to GDP ratio Including mining, manufacturing, construction and utility. Source: IMF’s WEO.

39. The service sector in China is significantly underdeveloped The output of service industry to GDP ratio Source: IMF’s WEO.

40. China has a relatively lower fiscal deficit Fiscal Position to GDP Ratio, % Source: IMF’s WEO.

41. China has a much lower public debt Public Debt to GDP Ratio, % Source: IMF’s WEO.

42. China’s M2 to GDP ratio is extremely high M2 to GDP Ratio Source: CEIC .

43. Why does China have to change its development model? • The shrinkage of external demand after the burst of global financial crisis: the deleveraging of U.S. households; the deepening of the EU Zone debt crisis • The excess capacity and low yields of China’s huge investment of manufacturing and infrastructure due to the weak domestic consumption • New NPL wave and fiscal problem • The demographic surplus is vanishing • The bottleneck of energy and commodities (China’s term of trade is exacerbating) • The safety of foreign exchange reserve suffering new potential shocks • The risks of higher inflation and asset price bubbles are looming

44. China’s Policy Commitment to the G-20 and Its ‘Significant’ Progress • Fiscal policy: • Continue to implement a pro-active fiscal policy • Reduce the fiscal deficit to around -1.5% of GDP (2012) • In 2011, it was -1.8% of GDP • Strengthen efforts to manage local government debts and prevent risks • Further improve the structural tax reduction policies • Raising the individual income tax threshold on salaries from 2000 yuan to 3500 yuan per month and adjusted the tax rate base • Continuing to implement preferential income tax policy for some small businesses with low profits and initiating a series of relief and exemption policies for tax and fee • Putting into effect lower provisional import tariffs on over 700 resource products, basic raw materials and key components • Strictly control new debts of local governments

45. Significantly enhance the ability of fiscal macro-regulation, further optimize the structure of fiscal revenue and expenditure, make further progress in fiscal and taxation reform, improve the scientific and meticulous management of public finance, and build a fiscal and taxation system conducive to the transformation of economic development pattern (2011-2015). • Continuing to expand household consumption • Supporting to improve people’s living standards • Advancing the fiscal and taxation reform

46. Monetary and exchange rate policy • Implement a prudent monetary policy and keep FRE (Aggregate Financing to the Real Economy) at at an appropriate level. (2011, 2012) • Broad money supply (M2) increases by 16% in 2011 and 14% in 2012 • Improve conduct of monetary policy • Optimize monetary policy target system, improve the transmission mechanism and environment of monetary policy

47. Further promote the reform of RMB exchange rate regime (Medium-term to long-term) • As of March 30, 2012, the central parity of RMB/USD exchange rate appreciated by 5.22% since the end-2010 and 31.49% since July 2005. • As of February 2012, RMB REER appreciated by 30.28% since July 2005, ranking 4th in the 58 countries in terms of appreciation. • Promote foreign exchange management regime reform • Foreign reserves grows at a slower pace, and even declines in late 2011

48. Expand the use of RMB in cross-border trade and investment • In Dec. 2011, RMB Qualified Foreign Institutional Investors scheme was launched, allowing HK-based subsidiaries of mainland fund management companies and securities companies to use RMB raised in HK to invest in securities in the mainland. • In March 2012, all qualified enterprises were allowed to settle exports in RMB • Capital account convertibility • With regards to RMB FDI, the process of capital verification inquiry and reinvestment is streamlined, and the approval process for purchase and payment in foreign exchange is removed. • Both domestic and foreign funded enterprises are allowed to use foreign currency receipts as collateral to obtain RMB loans

49. Financial sector policy • Further promote financial reforms • Deepen the reform in financial institutions • Optimize modern financial corporate system • Strengthen internal governance and risk management • Accelerate the development of multi-level financial market system • Promote the establishment of a counter-cyclical macro-prudential policy framework • Strengthen the financial regulation and improve financial supervision coordination

50. Structural Reform • Promote the strategic adjustment of economic structure (2011-2015) • The household consumption rate increases • Demand structure become more balanced among investment, consumption and export • In 2011, domestic demand contributed 106 % to growth • Contribution of final consumption rose to 52%, compared with 42% in 2010 • Promote a basically balanced BOP account • Trade surplus falls to a six-year low, decreasing by 48% from 2008-2011, from 6.7 percent of GDP to 2.6% • Current surplus as a percent of GDP drops from the record high of 10.1 in 2007 to 2.76 in 2011 • Policy adjustments have been made that remove barriers, including encouraging the use of foreign exchange, encouraging imports, and accelerating the Going Global Strategy • Outward investment averaged, 39.1bilion USD annually from 2006 to 2010, up 870% from the average level in 2001-2005 • In 2011, China announced a zero tariffs treatment for imports under 97% items from least developed countries • Accelerate the development of the service sector and raise its value-added contribution to the GDP by 4% • Increase the urbanization rate by 4% • Urbanization rate exceeds 50% as end-2011 • Increase spending on R&D to 2.2% of GDP