• Executive Summary

• Major Economic Trends
  Economy growth barely surpassed 7% target
  Growth in bank savings slowed down
  Retail sales grew faster in the fourth quarter of 1999

• Other Business News
  State sector investment will remain robust in 2000
  Government encourages private investment
  Greater support given to high-tech industries
  Domestics insurers allowed to sell 25% stake to foreign investors
  Debt-for-equity swap scheme to continue

• China Major Economic Indicators

Executive Summary

China's savings deposits growth eased from 18.3% year-on-year in the first half of 1999 to 11.6% at year-end, thanks to the reduction in deposit interest rates and the 20% tax on interest earnings from bank deposits levied since November 1, 1999. Savings were diverted to other investment vehicles such as insurance policies, bonds and shares, through which idle bank funds are channeled more efficiently to productive uses by listed firms and government.

Revenue collected from taxing the interest earnings on bank deposits since November 1999 was used to fund the increase in salaries of middle- and lower-income urban residents, pensioner and unemployment benefits. This, in turn, helped support stronger retail sales in the fourth quarter of 1999. Whether the pick up of retail sales growth would be sustainable, however, remains to be seen, as the threat of unemployment is expected to exacerbate further this year.

As private investment is expected to remain sluggish, the Ministry of Finance announced that another RMB100 billion worth of special bonds will be issued this year to finance government spending to support economic growth. Funds will be used to develop the western and central provinces, and support technological upgrades of state enterprises. However, increased government borrowing would boost the country's public debt substantially to 14.3% of GDP in 2000.

Regulations easing the requirements on private companies' establishment have been announced in January to encourage the development of private enterprises. Apart from alleviating the protracted reliance of China's economy on the state sector, the development of private enterprises would also help ease the social burden of increasing unemployment that is resulting from the state sector reform efforts.

In place of slackening FAI, robust export growth came to spur China's economic growth in the second half of 1999. Thanks to the increase in export value-added tax rebate and recovering economies in Asia during the year, exports reversed the declining trend in the first half of 1999 and grew by 6.1% for the whole year, up from 0.5% in 1998. The strong rebound of exports has helped put a floor on the decline in GDP growth that was triggered by waning government spending.

Looking ahead, FAI is expected to pick up as the government invests more funds into the development of western and central provinces, and the technological upgrades of the state sector. Meanwhile, sustained economic growth in the US and neighboring Asian countries would continue to boost exports, bringing a 10% growth to the export sector this year. On the strength of expanded government spending and robust exports, China should be able to attain its 7% growth target for 2000.

As a result of measures taken by the government to encourage people to spend more and save less, the growth in China's savings deposits eased from 18.3% year-on-year in the first half of 1999 to 15.1% in September and further to 11.6% at year-end. As part of the government effort to boost domestic consumption and curb deflation, the People's Bank of China announced a cut in bank deposit rates in June 1999. Savings deposit rate came down from 1.44% to 0.99% and five-year deposit rate was reduced from 4.5% to 2.88%. The measure was further complemented with a 20% tax on interest earnings from bank deposits levied by the government beginning November 1, 1999 to discourage people from putting money in the banks.

Although the interest tax levy has appeared to have put a drag on savings deposits growth, the state media reported that there has been little evidence of funds flowing into consumer spending. Instead, savings were diverted to other investment vehicles such as insurance policies, bonds and shares. A shift in fund use is, however, deemed better than having savings parked idle in China's banks. Concerned about deteriorating loan quality, China's banks have been reluctant to lend. Despite the 13.7% growth in bank deposits in 1999, loans increased by only 12.5% last year, compared to 21.4% in 1997.

With idle savings shifting from banks to the stock and bond markets, private funds would be channeled more effectively to productive uses by listed firms and government. Given that insurance companies also purchase bonds and indirectly invest in China's A-share market through mutual funds, savings channeled to insurance policies would also find their way in more productive uses. The more efficient use of savings would help spur investment and stimulate economic growth.

Although the slowdown in bank savings growth had not translated into a parallel increase in consumption, the revenue collected from taxing interest earnings from bank deposits has helped the government fund the various income boosting measures introduced in September 1999. The measures, which include the increase in salaries of middle- and lower-income urban residents, pensioner and unemployment benefits, have helped boost retail sales towards the end of the year. Stronger retail sales growth was further supported by the week-long National Day holidays in October. As a result, retail sales volume growth is estimated to have edged up to 10.9% in the fourth quarter and 10% for the whole year, compared to 9.7% in 1998.

Whether the pick up of retail sales growth would be sustainable, however, remains to be seen. With the ongoing reform in state-owned enterprises, the Ministry of Labor and Social Security estimated that as much as 12 million state employees would lose their jobs this year. Exacerbating threat of unemployment would prompt people to be even more cautious about spending their money.

State sector investment will remain robust in 2000

Amid the strenuous process of reforming state-owned enterprises, the Chinese government has increasingly recognized the importance of nurturing private sector investment. Recently, the government has stepped up measures to support the development of private domestic enterprises, aside from encouraging Sino-foreign joint ventures with established multinational corporate names.

According to a new regulation on the procedures for the Registration of Individually Funded Enterprise published by the State Administration for Industry and Commerce on January 17, individuals are allowed to register the establishment of a new enterprise by simply declaring the amount of investment. Previous requisites of presenting bank certificates, and maintaining a minimum number of employees have been excluded from the new regulation. As the relaxed regulation would simplify the registration process and lower the start-up cost for private enterprises, more aspiring entrepreneurs would be encouraged to start their own business. Furthermore, the People's Bank of China has appealed to the commercial banks, urging them to provide more loans to small- and medium-scale businesses to accommodate the funding needs of private enterprises.

By encouraging the development of private enterprises, the government aims to gradually alleviate the protracted reliance on state sector investment. At the end of 1998, state-owned enterprises accounted for 54% of fixed asset investment and 71% of China's total employed population, reflecting the dominance of the state sector in China's economy. The development of private enterprises would also help ease the social burden of rising unemployment resulting from the reform of the state sector.

More tax concessions will be made available to local firms that set up their operations in the high-tech development park near the Capital International Airport in Beijing. The investment venue was set up particularly to attract Chinese scholars returning from overseas to start-up their own technology-related business in China. Created by the Beijing Service Center for Scholarly Exchange and Beijing Airport Industrial Zone, the 20,000 square meter development park was inaugurated on December 17, 1999. Preferential policies to be enjoyed by companies with less than RMB10 million investment in the development park include a three-year period of income tax waiver and another three-year period to enjoy income tax concessions. Property used for business operation and research and development purposes will also be provided free of rent for two years. Even better preferential treatment could be accorded to ventures with above RMB10 million investments. So far, two local bio-technology companies have been set up in the park and they are planning to establish China's largest center for genetic research and development on the site with an investment of US$ 100 million over three-years' time.

Domestic insurers allowed to sell 25% stake to foreign investors

The new regulation is expected to receive warm welcome from foreign insurers, as they would be able to gain a wider access to China's insurance market before further deregulation takes place in three to five years after China's accession to the World Trade Organization (WTO). At present, foreign insurers are allowed very limited access in China, with geographic operations restricted to Shanghai and Guangzhou only and business scope limited to dealings with individuals. Under a deal with the US on China's entry to the WTO, these restrictions would gradually be relaxed. Geographical limits on the operations of foreign and foreign-invested insurance companies will be lifted over a period of five years after China's entry to the WTO, while restrictions on foreign companies offering group insurance policies would be relaxed three years after China's WTO entry. By allowing foreign shareholdings in domestic insurance companies, the CIRC also hopes to bring in foreign expertise in insurance products to upgrade the knowledge of local insurance personnel.

Enterprise reform

Debt-for-equity swap scheme to continue

In 1999, China unveiled a debt-for-equity swap scheme to restructure the bank debt of state enterprises. According to the plan, government-owned asset management companies (AMCs) would buy up the bad loans of the four state commercial banks due by the state-owned enterprises (SOEs) and trade the loans for equity shares in the debtor enterprises. Through converting debt into equity, the plan would ease the interest payment burden of the SOEs and help avert a liquidity crisis that could bring the debt-ridden companies to their knees. The AMCs, which have become shareholders of the SOEs will, in turn, have to beef up the management of the state firms to boost efficiency, so that they would later on be able to sell their stakes in the revived firms and recover the cash they injected.

The push for management restructuring has, however, upset the local authorities who run the SOEs as they feared that their employment prospects would be jeopardized. As reported in the local media, the debt-for-equity scheme has been stalled recently due to unresolved disputes between the AMCs and local authorities. Meanwhile, the AMCs are also reportedly bargaining for better terms with the central authorities to protect the value of their investment. Apart from asking for re-appraisal of the SOEs' net asset value, AMCs are reportedly urging the government to provide some form of buy-back guarantee in case the shares of the revived state firms do not attract sufficient investor interest.

Despite the disruptions, the government's intent to restructure the SOEs remains in tact and the State Economic and Trade Commission has reiterated that the debt-for-equity plan is still in progress. Given that the objective of the plan is to introduce new ownership and management into the inefficient SOEs to help them restructure and regain profitability, the central government would continue to approve debt-for-equity agreements that contain feasible plans for sincere restructuring of the SOEs' management and operation. Restoring the efficiency of the SOEs would, in turn, be the best guarantee for the AMCs to recover their investment.