• After having fallen for seven consecutive years, the growth of the Chinese economy is expected to pick up again in 2000. Aided by a recovery of domestic demand and a strong turnaround of exports, China's real GDP growth is forecast to rise from 7.1% in 1999 to 7.5% in 2000. As demand picks up and excess capacity runs down, consumer price index is also expected to reverse its falling trend which began in February 1998 and increase by 1.6% in 2000, compared to a decline of 1.4% in 1999.

• Domestically, consumer spending would be boosted by the increase in government social security payments which helps to cushion the dampening effect of rising unemployment, as well as the fall in real interest rates which tends to depress savings and encourage consumption. Meanwhile, China's expected accession to the WTO would boost investment, as foreign companies expand their operations to gain a firmer foothold in China and the government increases spending to help state enterprises upgrade technology to boost competitiveness.

• Externally, robust growth in the US and faster recovery of Asian economies would support a strong rebound of China's exports. The sharp increase in exports would partly offset the rise in imports due to stronger domestic demand and soaring world oil prices, and contribute to a sizable trade surplus of US$ 25.7 billion in 2000. With sizable trade surplus and increased inflow of foreign direct investment in the run up to the country's WTO accession, China is under no immediate pressure to devalue its currency.

• Although improved domestic and global economic conditions would help China reverse its declining growth trend, the realization of sustained economic growth requires the resolving of the structural problems in the banking and state-owned enterprises sectors. There are encouraging signs that important steps have already been taken to address these problems. As banks begin to increase lending again and the efficiency of state enterprises further improves, China should be able to grow at a more sustainable rate in the long run.

At a time when most Asian economies are gradually recovering from recession, the growth of the Chinese economy has continued to slow. The growth of real gross domestic product (GDP) declined from 8.3% in the first quarter of 1999 to 6.8% in the fourth quarter (see figure 1), bringing growth for the whole year to 7.1%, just barely surpassed the 7% government growth target.

The slowdown in 1999 was mainly due to a sharp decline in the growth of domestic investment. As a result of the exhausting of a RMB100 billion special treasury bonds issued by the government in late 1998 to stimulate infrastructure spending, the growth of state-sector fixed asset investment fell from 22.7% in the first quarter of 1999 to 5.2% in the fourth quarter (see figure 2). Facing vast excess production capacity, private enterprises also had little incentive to increase investment. This is especially the case when bank credits had remained prohibitively tight. As a result of concerns over the weak loan quality, banks have been reluctant to increase lending. In the fourth quarter of 1999, the growth of loans to the non-state sector declined to 11.8%, down from 15.7% in the first quarter.

Growth Prospects

The declining growth trend is, however, expected to reverse course in 2000. Thanks to improved domestic economic condition and favorable global economic environment, the growth of the Chinese economy is expected to pick up again this year.

Consumption

Domestically, although rising unemployment due to the restructuring of state-owned enterprises would continue to dampen consumer confidence, the impact on consumption would be mitigated by the increase in government's welfare payments. In the budget for 2000 unveiled at the annual session of the National People's Congress in March, the government announced a doubling of social security payment to the unemployed and retired state sector workers to RMB70.7 billion in 2000. Increased social security payments would boost the income of the jobless workers and lend support to the recovery of consumption.

The fall in real interest rates would provide a further boost to consumer spending. Thanks to a cut in interest rates in June 1999 and the easing of deflation since mid-1999, the real return on bank deposits has sharply declined. For example, the real interest rate on one-year time deposits fell from 6.1% in May 1999 to 1.5% in February 2000 (see figure 3). Taking into account the effect of a 20% interest income tax levy on bank deposits implemented in November 1999, the effective return would be slashed by a further 0.45 percentage points to a low of 1.1%. With deflation expected to continue to ease, real interest rates are likely to decline further. Falling real interest rates would tend to depress savings and encourage consumption.

Investment

China's expected entry to the World Trade Organization (WTO) later this year would also boost investment and stimulate economic growth. Although any real improvement of market access would probably not be seen until 2002, foreign companies have already stepped up their investments in China in preparation for the expanded business opportunities. In anticipation of increased distribution capability in China, foreign investors who already have a presence on the mainland would also expand their operations to gain a firmer foothold before other competitors get the chance to enter the market to compete with them. The inflow of foreign direct investment is, therefore, expected to increase in the run up to China's WTO accession.

As foreign companies expand their operations in China, the government is expected to step up its efforts to enhance the competitiveness of the domestic enterprises. In line with the government's priority to modernize the state-owned enterprises to boost their competitiveness, state grants and interest subsidies to the state sector will increase by 170.5% to RMB16.5 billion in the budget for 2000 to help the state enterprises upgrade equipment and technology. The sharp increase of funding on technical upgrade by the state sector would cushion the 39.9% decline in government spending on capital construction in this year's budget and provide a boost to public sector investment.

Exports

Externally, the strong turnaround of exports would lend further support to economic growth. After having contracted by 4.7% during the first half of last year, China's exports rebounded by 15.8% in the second half, thanks to the increase in export value-added tax in July which helped to boost the liquidity of China's exporters. On the back of improved global economic environment, exports surged further by 41.2% in the first two months of 2000 (see figure 4). As the recovery of Asian economies is expected to gain further momentum and the robust economic growth in the US is likely to continue, the demand for Chinese goods would remain keen. It is expected that China's exports would grow by a massive 21.7% in 2000, up from the 6.1% in 1999.

Economic outlook

Aided by a recovery of domestic demand and a strong turnaround of exports, China's real GDP growth is expected to rise from 7.1% in 1999 to 7.5% in 2000 and further to 7.8% in 2001. As demand picks up and excess capacity runs down, deflation would also ease. The easing of deflation would further be supported by the government's move to raise fees in the areas of housing, transportation and education to provide the funding for infrastructure construction. National consumer price index is, therefore, expected to reverse its falling trend which began in February 1998 and increase by 1.6% in 2000, compared to a decline of 1.4% in 1999.

Currency Stability

Apart from providing a strong boost to growth, the sharp increase in exports would also partly offset the rise in imports due to stronger domestic demand and soaring world oil prices, and contribute to a sizable trade surplus of US$ 25.7 billion in 2000, comparable to the US$ 29.2 billion in 1999. China's balance of payments position would further be bolstered by the increase in capital inflows. In the run up to China's entry to the WTO, foreign direct investment is expected to increase. Meanwhile, the inflow of foreign portfolio investment would also increase as Chinese companies resume overseas listing. It is reported that Chinese enterprises would raise a total of US$ 13-18.5 billion through listing in the Hong Kong stock market this year.

Given this year's favorable balance of payments position, China is under no immediate pressure to devalue its currency. Meanwhile, the government may also be reluctant to see a stronger Renminbi as it would hit the current export-led growth momentum of the economy. It is, therefore, unlikely that China would widen the fluctuating band of its exchange rate in the near future, as widely speculated in the market. However, as China's foreign trade rapidly expands after the country's accession to the WTO, the need for using exchange rate as a macroeconomic government policy tool will grow. The move to a more flexible exchange rate regime would, therefore, be necessary in the longer term.

Economic Reform

Although improved domestic and global economic conditions would help China reverse its declining growth trend, the realization of sustained economic growth requires the resolving of the structural problems in the banking and state-owned enterprises sectors. Constrained by the financial burden of massive non-performing loans, banks will be unable to sharply increase lending to finance growth. Meanwhile, as capital and labor resources are being tied up in inefficient state enterprises, the growth potential of the country will also be curtailed.

State commercial banks

In a bid to improve the loan quality to encourage banks to lend more, the People's Bank of China (PBOC) had set up four asset management companies (AMCs) between March and October 1999 to take over the non-performing loans of the four state commercial banks. Under the PBOC plans, each of the AMCs received a capital injection of RMB10 billion from the Ministry of Finance and is allowed to raise further operating funds through corporate bond issues and commercial loans. The funds raised would then be used to acquire the problem loans of the state banks, thereby shifting the burden of non-performing loans to the AMCs. By the end of 1999, the four AMCs had reportedly purchased a combined RMB350 billion, or an estimated 22% of the total non-performing loans of the state banks.

With the reduction of problem loans, banks will be more willing to increase lending. However, more needs to be done to improve bank management and banking practices, which are crucial in avoiding future problem loans. In this respect, the reshuffle of top banking officials in February 2000 is a step in the right direction. Through the redeployment of expertise, the reshuffle would help to strengthen the management of the state banks. Meanwhile, the government also approved new regulations in March 2000 which will lead to the establishment of independent supervisory committees appointed by the State Council to monitor the performance of the management of the state banks. With the help of the supervisory committees, the government hopes to increase the accountability of banks' senior managers to avoid misallocation of bank funds.

State-owned enterprises

In connection with the establishment of the AMCs to take over the non-performing loans of the state banks, the government also unveiled a debt-for-equity scheme in August 1999 to restructure the bank debt of the state-owned enterprises (SOEs). According to the scheme, the AMCs would trade the problem bank loans it acquired for equity stakes in the debtor enterprises. The equity could then either be held by the AMCs, or repackaged and sold to investors, including foreigners. Through converting debt into equity, the scheme would ease the interest payment burden of the SOEs and help avert a liquidity crisis that could bring the debt-ridden enterprises to their knees. By the end of 1999, the four AMCs had reportedly signed debt-for-equity swap agreement with 66 enterprises involving a combined RMB83.5 billion of debt.

In the long run, for the scheme to effectively serve its purpose of reviving the state enterprises, material changes in the economic efficiency of the SOEs have to be pursued. Otherwise, swapping debt for equity will simply amount to throwing good money after bad. In particular, efforts should be made to upgrade production technologies and develop human resources. Towards these ends, the government announced at the annual session of the National People's Congress held in March to allocate RMB16.5 billion for upgrading technologies of the SOEs. Premier Zhu Rongji has also urged the SOEs to experiment with private sector compensation schemes, such as performance-linked salary system and stock options program, to motivate the state employees and increase the efficiency of the enterprises.

Conclusion

After having fallen for seven consecutive years, the growth of the Chinese economy is expected to pick up again in 2000, thanks to a recovery of domestic demand and a strong turnaround of exports. As demand picks up and excess capacity runs down, China's two-year long deflationary trend is also set to reverse course. The cyclical rebound of the economy could, however, quickly run out of steam if the structural problems in the banking and state-owned enterprises sectors are left unresolved. There are, however, encouraging signs that important steps have already been taken to address these problems. As banks begin to increase lending again and the efficiency of state enterprises further improves, China should be able to grow at a more sustainable rate in the long run.

China Major Economic Indicators

Jason Kwok
North Asia Chief Economist

Joe Lo
Senior Economist

Ellen Cheuk
Economist

Alice Chan
Senior Information Officer

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