• Executive Summary

• Major Economic Trends
  Export growth slid to 0.9% in August
  FDI in China expected to remain robust in 2001
  State sector stepped up investment in fixed assets

• Other Business News
  Taiwan to repeal "no haste, be patient" policy
  China's WTO bid nears completion
  China to allow the establishment of foreign venture-capital funds
  PBOC regulates lending against tax rebates used as collateral
  PBOC took action against bank NPLs
  

• China Major Economic Indicators

EXECUTIVE SUMMARY

• As global economic growth continued to be sluggish, China's exports grew by only 0.9% year-on-year in August. In the remainder of the year, China's export growth could ease further due to the prolonged slump of the US economy. Following the terrorist attacks on the US on September 11 which substantially eroded the earlier optimism of a year-end recovery of consumer confidence, US demand for China's products are unlikely to recover in the fourth quarter, and export growth could slide to 5.5% this year from 27.8% in 2000.
  
  
• Despite the sluggish global economic environment, FDI in China continued to ride on the country's imminent entry to the WTO, which would allow foreign investors to take advantage of the lower operation costs in the mainland, and the wider access to the populous China market. Barring further terrorist activities which could escalate the threats of war and further erode investment confidence, the business opportunities arising from China's WTO entry should keep foreign investment funds flow to China robust in the medium term.
  
  
• Fixed asset investment growth in China edged up further to 18.9% year-on-year in the first eight months this year, the highest since March 1999. Facing possibly further contraction of China's export growth in the coming months, the government is likely to step up spurring domestic demand by continued investment. Finance minister Xiang Huaicheng indicated recently that the government's proactive fiscal policy would continue into 2002 with the support of another RMB150 billion treasury bond issue.
  
  
• Following Taiwan president Chen Shui-bian's endorsement of a set of recommendations made by the Economic Development Advisory Council (EDAC), a series of policy relaxation on cross-strait business relations including mainland-bound investment cap were announced. Although the moves represented more accommodating mainland policy stance on the side of Taiwan, the economic impact on China is limited given that Taiwan businesses have already circumvented previous restrictions and coursed their investments through companies registered overseas.
  
  
• With the sealing of a trade agreement with Mexico, and the US and Europe agreeing to put aside their dispute on the access to China's insurance market until after the country's entry to the WTO, the WTO Working Party passed the relevant documents on China's WTO bid on September 17. The documents will be forwarded to the WTO General Council for final approval in November and then to China's National People's Congress for ratification and 30 days thereafter, China will become a full-fledged member of the WTO.
  
  
• On September 19, the MOFTEC, Ministry of Science & Technology, and State Administration of Industry and Commerce jointly issued a set of provisional regulations allowing foreign venture- capital funds to set up wholly-owned or joint venture companies in China. To attract investors' interest, China has put in place exit mechanisms including share buy-backs and public listing of shares in the venture companies to enable foreign venture-capitalists to realize the profits they make from their mainland ventures.
  
  
• To help exporters cope with the slipping export demand, some provinces and municipalities started to allow exporters to borrow from banks using their expected export tax rebates as collateral. While the government commended such initiatives, banks were also urged to maintain prudent lending policies by limiting the loan value to 70% of the export tax rebate and the tenure to one year.
  
  
• To push banks to reduce their NPL ratio, the PBOC conducted rigid examination on the financial accounts of selected state commercial bank branches and penalized bank officials who were found to have engaged in imprudent lending practices. The action reflects the central bank's determination to prepare the state commercial banks for competition against their foreign counterparts upon China's entry into the WTO.
  

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MAJOR ECONOMIC TREND

Export growth slid to 0.9% in August

As global economic growth continued to be sluggish, China's exports grew by only 0.9% year-on-year in August, bringing export growth for the first eight months this year to 7.3%, down significantly from 27.8% in 2000.

Growth of exports to the two largest markets of the US and Japan continued to lose momentum as their economies remained lackluster. In the first eight months, exports to the US increased by only 5% compared to 24% in 2000, and exports to Japan expanded by 11%, down from 28% a year ago. In terms of product category, exports of items traditionally destined to the US market grew at a rather slow pace during the first eight months this year. Garments exports edged up only 1.6% and textiles increased only 4.4% compared to last year's 19.8% and 23.7% respectively. Exports of toys even declined by 9.9% compared to the 9.1% growth in 2000.

In the remainder of the year, China's export growth could ease further due to the prolonged slump of the US economy. Following the terrorist attacks on the US on September 11 which substantially eroded the earlier optimism of a year-end recovery of consumer confidence, US demand for China's products are unlikely to recover in the fourth quarter of this year. China's export growth in 2001 could therefore slide to only 5.5%.

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FDI in China expected to remain robust in 2001

Despite the sluggish global economic environment, foreign direct investment (FDI) in China continued to show steady growth. During the first eight months this year, contracted and utilized FDI in China rose 43.8% and 27.4% respectively, compared to 52.2% and 1% in 2000. Inflow of foreign funds continued to ride on China's imminent entry to the World Trade Organization (WTO), which would allow foreign investors to take advantage of the lower operation costs in the mainland and the wider access to the populous China market.

Although the market is expecting worldwide investment funds flow to recede after the September 11 terrorist attacks on the US, the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) expects the impact on China's FDI to be subdued, and that the targeted 10-15% growth in utilized FDI this year is likely to be met. Optimism is mainly due to last year's surge in contracted FDI, which amounted to US$ 62.7 million and would gradually be put into use. Moreover, now that the accord on China's entry to the WTO has passed the formal meeting of the WTO Working Party on September 17, China is only months away from officially joining the multilateral trade body. Barring further terrorist activities which could escalate the threats of war and further erode investment confidence, the business opportunities arising from China's accession to the WTO should keep foreign investment funds flow to China robust in the medium term.

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State sector stepped up investment in fixed assets

Fixed asset investment growth in China edged up further to 18.9% year-on-year in the first eight months this year, from 18.4% in the first seven months and was the strongest recorded since March 1999. All sectors recorded more rapid growth rates this year. With construction activities ongoing in the western provinces, investment in infrastructure, which accounted for roughly half of the total, rose 11.7% in the first eight months this year to RMB697.8 billion, while state enterprises' spending on technical upgrading jumped 26.7% to RMB262.4 billion. Investment in property even soared by 32.1% in the period to RMB318.8 billion, thanks to China's housing reform which helped fan a residential housing boom in the country's major cities.

Facing possibly further contraction of China's export growth in the coming months, the government is likely to step up spurring domestic demand by continued investment. Despite concerns of an excess strain on government coffers brought about by the massive state sector spending, the State Development Planning Commission (SDPC) has indicated that it is still too early to phase out China's proactive fiscal policy. This is because the uncompleted projects financed by treasury bonds issued in the past still need around RMB600 billion to wrap up, and the large-scale development in western China would require further funding from the central government. As such, state sector spending on fixed asset investment would likely remain a major engine of economic growth for the country in the short term.

Finance minister Xiang Huaicheng indicated recently that the government's proactive fiscal policy would continue into 2002 with the support of another RMB150 billion treasury bond issue. Between 1998 and 2001, the government has already issued RMB510 billion of long-term treasury bonds to fund a total investment of RMB2.4 trillion covering over 8,500 projects so far.

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OTHER BUSINESS NEWS

Cross-strait relations

Taiwan to repeal "no haste, be patient" policy

On August 26, Taiwan president Chen Shui-bian endorsed a set of recommendations made by the Economic Development Advisory Council (EDAC) which called for "active opening and effective management" of cross-strait business relations. In contrast to the previously advocated "no haste, be patient" policy, which was introduced by the government in 1996 to curb the surging flow of Taiwan investments to the mainland and avoid an over-dependence on the mainland economy, the recommendations submitted by the advisory council urged the government to allow more cross-strait tourist exchange, greater flexibility in cross-strait investment, as well as more serious efforts in preparing for direct "three links" (trade, transportation and postal links).

Following Chen's endorsement of the EDAC recommendations, Taiwan's Cabinet approved a series of policy relaxation on cross-strait business relations. On September 5, Taiwan announced the passage of a proposal which allows the extension of the "mini three links" experiment to Penghu Island. Concurrently, the Cabinet also approved a bill revising the Statute Governing Relations between the People in Taiwan and Mainland China to allow mainland individuals and institutions to invest in Taiwan's real estate market.

Further on September 19, Taiwan announced that the curbs on large mainland investments would be lifted. The previous investment cap of US$ 50 million which applied to each project undertaken by a Taiwan firm on the mainland will be replaced by an annual ceiling on the firm's overall investment. The annual ceiling would be determined based on Taiwan's macroeconomic conditions and would be adjusted periodically.

The latest round of relaxations followed steps taken by the Taiwan government since the start of this year to ease cross-strait restrictions on expectation that Taiwan would follow China in joining the World Trade Organization (WTO) by year-end. Under WTO rules which call for non-discriminatory and reciprocity treatment among its members, Taiwan would have to abolish the ban on direct links with China once it becomes a member of the multilateral trade body. In January, Taiwan formally opened direct three links between its offshore islands of Kinmen and Matsu, and the nearby Chinese ports of Xiamen and Fuzhou in the Fujian province. In May, Taiwan's Ministry of Finance eased a restriction which limited Taiwan companies listed on the main board and over-the-counter stock exchange to invest no more than 20% of the funds they raised from overseas sources into their mainland ventures, and raised the ceiling to 50%.

Although the new plans indicate a more accommodating mainland policy stance on the side of the Taiwan government, the economic impact on China is likely to be limited. An extension of the "mini three links" to a third offshore island would make limited contribution to cross-strait trade. Furthermore, many of the Taiwan businesses have already circumvented existing restrictions by coursing their mainland-bound investments through companies registered overseas, mainly in Hong Kong. The latest relaxations only help to legitimize transactions already existed before. Including the investment on the mainland without formal approval from Taiwan's government, China statistics showed that utilized Taiwan investment in China already totaled US$ 27.5 billion between 1979 and June this year. A significant part of Hong Kong's US$ 150 billion cumulative investments in China during this period is also believed to have come from Taiwan-funded Hong Kong enterprises in China.

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Foreign trade and investment

China's WTO bid nears completion

On September 18, the World Trade Organization (WTO) Working Party passed the relevant documents on China's accession to the multilateral trade body, bringing the country only months away from becoming a full-fledged member of the organization. These documents include the protocol and the report of the working party which detail the terms under which China guarantees to admit foreign goods and services as well as outside firms into its markets. The approval came after Mexico signed a bilateral trade agreement with China, and the US and European Union concurred to put aside their dispute over the access to China's insurance market until after the country joins the WTO.

In the Sino-Mexican trade deal signed on September 13, China agreed to reduce tariffs and other non-tariff barriers on more than 260 Mexican products, and allow Mexico to keep its current countervailing duties of up to 1,500% on a range of over 1,300 Chinese products for six years after China enters the WTO. Most of the items involved are labor intensive goods such as garments, textiles, toys and footwear. China further agreed to allow Mexico to extend the import duties beyond the six-year period if unfair practice such as dumping from China's side is proven. Mexico had reportedly sought to shield its industries from direct competition with cheap Chinese products for up to 15 years.

After being passed by the Working Party, the protocol and working party report will be forwarded to the WTO General Council for final approval at the fourth WTO Ministerial Conference scheduled to take place on November 9-13. The protocol will then be forwarded to China's National People's Congress (NPC) for ratification. China will formally become a member of the WTO 30 days after the ratification procedures are completed. Given that the NPC meets only once every two months, the ratification will unlikely complete before December, unless a special session is called for at an earlier date.

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China to allow the establishment of foreign venture-capital funds

On September 19, China's Ministry of Foreign Trade and Economic Cooperation (MOFTEC), Ministry of Science & Technology, and State Administration for Industry and Commerce jointly issued a set of provisional regulations that would lift existing restrictions which ban foreign venture-capital funds from entering the mainland market.

According to the new rules, qualified foreign venture-capitalists would be allowed to set up wholly-owned venture-capital companies or enter into joint ventures with Chinese enterprises. In a Sino-foreign cooperative venture-capital firm, one of the foreign partners must have managed assets of over US$ 100 million in total and invested over US$ 50 million of these assets in the past three years. At least one foreign partner will be required to invest a minimum US$ 20 million in capital and hold no less than 25% stake in the new venture-capital company. Other participating foreign investors must each contribute a minimum of US$ 10 million and maintain at least a 3% stake. The authorities stressed, however, that venture-capital firms will be barred from investing in the local stocks, derivatives and futures markets. They will neither be allowed to make loans, underwrite or invest with borrowed money.

To attract investors' interest, China will allow foreign partners to receive bonus dividends from profits earned by their venture-capital companies in China. The sum could be converted into foreign currencies for remittance overseas. Exit mechanisms are also put in place under the new rules. Foreign investors may sell their stakes in the venture to other enterprises or individuals, or enter into agreements that would allow other shareholders in the venture to buy back the foreign investors' stakes. Alternatively, foreign partners may choose to take public part or whole of their stakes in the venture-capital companies. Share listings in both the local A-share market and overseas bourses would be permitted.

The provisional rules have been submitted to the central government for final approval, and more detailed guidelines are expected to be released within the year. The government hopes that the new regulations will be able to attract foreign investment funds to aid the development of the fledging small and medium-sized enterprises, particularly those engaged in the high-technology industries. Channeling more foreign funds to China would also help the local venture-capital sector to develop at a faster pace. According to the Xinhua News Agency, there were less than 200 venture-capital funds in China with a combined total capital of only about RMB30 billion as at the end of last year.

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Banking

PBOC regulates lending against tax rebates used as collateral

Since the Asian financial crisis, China has actively made use of the export value-added tax rebates as a tool to boost the price competitiveness of Chinese exports in the international market. Although tax rebates allowed exporters to set lower prices on their products, exporters usually had to wait for months to receive the funds from the authorities. As global demand turned weak again this year, some exporters have faced short-term liquidity problems. Some provinces and municipalities thus started to allow exporters to borrow from banks using their expected tax rebates as collateral. While the government commended such practice, banks were also urged to maintain prudent lending policies.

To limit the possible credit risks on banks, the People's Bank of China (PBOC) and the State Administration of Taxation (SAT) issued on August 31 a set of new rules to control the use of export tax rebates as loan collateral. According to the regulations, commercial banks are allowed to lend only up to 70% of the value of the expected export tax rebate and the loan tenure should be limited to one year. Moreover, exporters should open a special bank account into which the export tax rebates will be deposited to ensure that banks are able to recover the principal value of the loan extended.

Trade officials hope that allowing exporters to use their expected tax rebates as loan collateral would augment the current tax rebate scheme and render greater support to the country's export growth.

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PBOC took action against bank NPLs

As an attempt to push banks to reduce their non-performing loans (NPLs) ratio, the People's Bank of China (PBOC) examined the financial accounts of selected state commercial bank branches during the first half of this year. The central bank's investigative efforts focused on those branches of the four state commercial banks that had reported NPLs of over RMB100 million, or exceeding 30% of their total lending, at the end of 2000.

During the investigations, the central bank uncovered RMB6 million worth of problem loans extended by these banks, and reportedly found out that some of the bank branches had illegally approved loans to staff, extended loans to customers that exceeded the limits set by banks' internal risk controls, or issued credit cards and overdrafts to unqualified customers. Over 1,200 officers of 316 state commercial bank branches were reportedly penalized as a result of the PBOC investigations.

As China has committed to gradually open up its banking sector to foreign participation after the country's entry to the World Trade Organization (WTO), the central bank is determined to intensify efforts to reform the industry so that the four state commercial banks can be globally competitive. The first step taken towards this objective is to bring the scale of NPLs down to internationally acceptable standards. Aside from the establishment of asset management companies to take up part of the existing NPLs, the state commercial banks were urged to embark on a comprehensive reform and create prudent systems of internal control, accounting, and business performance appraisal to avoid further worsening of their NPL situations. The latest PBOC investigation was part of this effort.

At the start of this year, central bank governor Dai Xianglong directed the four state commercial banks to reduce their NPL loan ratios from over 30% to about 20% of total lending by end-2002. A PBOC official disclosed earlier that the proportion of NPLs at the state commercial banks dropped by 2.1% in the first six months of this year.

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CHINA MAJOR ECONOMIC INDICATORS

CITIBANK, N. A.
49/F Citibank Tower
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Tel : (852) 2868-8443

Jason Kwok
North Asia Chief Economist

Joe Lo
Senior Economist

Ellen Cheuk
Economist

Alice Chan
Senior Information Officer