Global financial crisis, China’s macroeconomic situation and policy responses

1. Global financial crisis, China’s macroeconomic situation and policy responses Institute of World Economics and Politics, CASS Yu Yongding 6 May Damascus

2. China’s growth since reform and opening up in 1979 • China’s average annual growth rate since 1979 is 9.8 % • China’s average annual growth rate from 2002 to 2007 was 10.5% • In 2008, China has become the 3rd largest economy, the 2nd largest trading nation, and the largest foreign exchange reserve holding country in the world. • However, due to the global financial crisis, the annualized growth rate of the third quarter of 2008, China’s growth rate fell into 6.8%

3. The impact on the economy is mainly through the trade channel FREE FALL 54% reduction in steel production in Sep. 2009 was caused directly by reduction in exports

4. Why impact on trade is so important for the Chinese economy • China’s growth was characterized by investment- driven and export- driven • China’s trade/GDP=70% • China’s export/GDP=40% • China’s current account surplus/GDP=8% (2007) • When the growth rate of China’s exports dropped dramatically, from 29% on average to -25.7% in February 2009, how great is the impact on the growth is not difficult to imagine. • The fall of foreign demand not only impacted on China’s growth directly but also via its impact on investment and consumption

5. China’s main policy responses to the global slowdown • The government acted promptly, in Nov. a stimulus plan was announced • Expansionary fiscal policy • The government acted promptly, in Nov. A 4 trillion Yuan ($580 billion) stimulus plan was announced • The stimulus package, will be used over 2 years • The package accounted for 14% of GDP in 2008 • Budget deficit will raise to 3% of GDP in 2009 • Why the government can adopt such strong stimulus package • Low budget deficit over the years, less than 1 % • Debt/GDP is less than 20 % • Accommodating monetary policy • Until the third quarter of 2009, China’s monetary policy was aimed at controlling inflation and fighting asset bubbles. However the direction of the policy changed dramatically • The policy is aimed at accommodating the expansionary fiscal policy

6. The Allocation of RMB 4 trillion Earthquake rebuilding Infrastructure investment Most of money will be spent on building railway, high way and so on, followed by earthquake rebuilding

7. China’s financing for investment(2007) 2007

8. Accommodating monetary policy • China’s financial condition • is not suffering from lack of liquidity, credit crunch • China’s banking system is safe and sound so far • NPL less than 5% • CA more than 8% • Assets bubbles are not that serious or have been corrected • Changes in monetary policy since the last quarter of 2008 • Abolishment of credit rationing • Lowering reserve requirement • Lowering interest rates on banks’ loans and deposits • Lowering the thresholds of down payments of mortgages • Less sterilization • M2=20%

9. signs of recovery: -- Changes in steel production and its decomposition Production of steel Contribution of investment inventory Net exports Most indicators show that the Chinese economy may have bottom out since the last quarter of 2008. I have no doubt whatsoever that China will be able to achieve a growth rate above 8% for 2009

10. Most serious challenge: balance between growth and structure adjustment • To achieve a sustainable growth and improve the welfare of the nation. Growth should not be achieved at the expenses of structure adjustment • Structure problems include • High external dependency • High investment rate • Pollution • Energy efficiency • Income distribution gap between different social group and between rural and urban areas • In sufficiency of provision of social goods (social safety net, medic-care, education, etc.) • If China fails to tackle these structural problems, growth is likely to have a W shape prospect

11. The Another Important Impact:Worry about the Safety of China’s Fx Reserves • Two trillion USD foreign exchange reserves • One trillion in USD assets mainly in US treasuries • Threats come from • Default of GEBs (400billion dollar Fanni and Freddi Bonds) • Extremely expansionary monetary policy by the Fed • Extremely expansionary fiscal policy by the Treasury • Rogoff : “Why would a government refuse to pay its domestic public debt in full when it can simply inflate the problem away?“ • America’s track record is not impeccable • In the short-run • The dollar is still strong • Prices of US treasuries are still high • This is temporary, is against fundamental • In the long-run • If the Fed fails to withdraw the liquidity which may be come excess in the future in a timely fashion, devaluation of Dollar in purchasing power will be inevitable • If the US fails to cut its budget deficit, the fall of the Gbond prices is inevitable • The debasing of dollar may have already lead to the devaluation of China’s treasury holdings, if China still holds the current US assets and even increases the holdings

12. What China can do? With regard to flows • Reducing trade surplus by increasing domestic demand, consumption demand in particular • Social safety network (pension, Medicare, unemployment insurance and minimum income guarantee) • Education (12 year free education) • Rural infrastructure • Narrowing gap in income distribution • Infrastructure investment • Facilitating Out- bound FDI • Overcapacity is huge (steel). If trade surplus cannot be eliminated, increase outbound FDI • construction of infrastructures in Asia, Africa and Latin America

13. What China can do? With regard to stocks • Diversification • Currencies (besides the dollar) • Types of assets (besides the Treasuries) • Buying precious metals and natural resources (besides financial assets) Easily said than done! China has already fallen into a dollar trap • Creating claims denominated by RMB rather than the US dollar • Engage in currency swap with central banks • Encourage the use of RMB as settlement currency • Increase contributions to the establishment of regional financial architecture (Asian Monetary Fund?) • Encourage foreign borrowers to issue Panda bonds • Extend RMB Loans to foreign borrowers • Increase contributions to international key stone organizations • Buy IMF bonds denominated in SDR • Road map • Reform of international monetary and financial system • Promotion of regional financial cooperation • Speed-up Renminbi internationalization, while maintain effective management of cross-border capital flows

14. Thank you!